Cryptocurrency market: Stablecoins Won’t be so stable | Tech News

Cryptocurrency market: Stablecoins won’t be so stable

Stablecoins have gone from an obscure corner of cryptocurrency market to near the center of it.

| Updated on: Aug 21 2022, 21:32 IST
As the cryptocurrency market matures, issuers will compete on the basis of quality, innovation and price. (Representational Photo) (MINT_PRINT)

Stablecoins have gone from an obscure corner of cryptocurrency market to near the center of it. Major institutions, such as Mastercard, are now trying to create alternate payment networks based on stablecoin and crypto.

I am rooting for such efforts to succeed, but in the meantime I have news for you: Stablecoins aren't always stable. Unlike a lot of critics, however, I view fluctuating prices for stablecoins as not only acceptable but also desirable.

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The potential for stablecoins is obvious. Imagine if software, using crypto, could circumvent some of today's banking and financial institutions, and all of their attendant costly bureaucracies. You could send remittances at lower cost, make payments more quickly, and receive a higher return on your deposits, at least if the transaction technology can be improved. Underlying these systems would be blockchains, with the coins pegged to dollars on a one-to-one basis by reserve backing. In fact, such assets already exist, and they are growing rapidly.

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Even if all goes well, why should those different brands of stablecoins remain priced at $1 apiece? In most well-functioning markets, suppliers compete on innovation, quality and price. That diversity is the natural outcome of trying to figure out which coin systems — fully stable or not — are best.

If market prices do not communicate this information, how can you discover it? In my vision, higher prices will signify a coin's quality and attract more business; the coins with strictly fixed prices will fill a niche; and the coins with lower prices will lose business, or otherwise serve as discount issues for those of lower means.

Stablecoin critics focus on fraud and the possibility of dramatic plunges in prices, and indeed many coins already have failed. Even conceding that regulation and the market will limit the more dramatic episodes, some coin issuers will be more stable and innovative than others. With market success will come market exit, and some issuers' prices will fall on the way out the door.

On a more positive note, if you think stablecoins serve so many new and marvelous functions, you would expect many of those assets to sell for more than a dollar.

Here I will date myself: I used to buy traveler's checks for my trips abroad. In many cases you had to pay a premium of a few percentage points; a hundred dollars in traveler's checks might cost you $102 or $103. That is because the checks offer theft protection services that cash does not.

More concretely, you might use other coins, less than fully backed, to underpin your lending through decentralized finance. Returns could be higher, but of course there is a risk that the backer could become insolvent. Prices for those coins would vary, though one goal would be to make them more stable than Bitcoin.

For another look at why prices won't stay fixed, consider the incentives of a stablecoin issuer. Let's say your issue is currently one-to-one with the U.S. dollar and you are holding 100% reserves of very safe assets. Might you then be tempted to go down to 98% reserves? 95%? If the price of your coin stays at $1, fine, you come out ahead. If the price declines in proportion to the new and higher risk, you as an issuer still have broken even. So it seems that coin issuers will have an incentive to test the one-to-one exchange rates by diluting their backing.

You will have some issuers pledge never to deviate from 100% reserves, as Gemini currently does. But they are likely to be only one brand of many. You might also be dealing with coins backed by euros, yen or other currencies.

You might think that regularly fluctuating prices on these various coins would be terribly inconvenient. But information technology allows you to call up exchange rates with the single press of a key, or by asking your smart phone (soon enough). Besides, these coins are to be only one part of the financial system, not something you use every day to buy a cup of coffee.

If my scenarios turn out to be accurate, will they be called “stablecoins” for long? “Unstablecoins” won't work. How about “stablercoins”? I'd like some of those — depending on the price, of course.

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First Published Date: 30 Oct, 00:27 IST