19th February 2019

Stablecoins: What’s that all about?

Colin Platt, again, time for another blog, exploring some of the topics that Zeth, Shaun and I found interesting and noteworthy. This week we look at cryptocurrencies.

For those of you who have been living under a rock, last week JP Morgan –the largest American bank– announced JPM Coin. A digital currency backed by deposits held at JP Morgan, aiming to speed up transfers among its institutional clients and reduce costs.

Regardless of where you stand on banks’ entry into the cryptocurrency space, it is interesting to see it happen during one of the deepest and longest bear markets since the advent of crypto assets. Of course JPMorgan is far from the first to experiment with crypto assets that seek to capture some of the benefits of cryptocurrencies, whilst reducing their price volatility. Let’s talk about some of the more well known efforts, and some of the reasoning behind why people believe that they are important.

Though a definitive definition has not yet been fully agreed across the market, in general there are two types of crypto assets that can be viewed as ‘stablecoins’, first are those backed by “crypto collateral” (e.g., Bitcoin or Ether fiat collateral) which are then transformed into more stable units of account (e.g., Dollars). The other are those backed by actual underlying fiat-balances (e.g., cash in a bank account). Though not exclusively, a majority of stablecoins seek to track the price of $1.00 (USD).

There have also been attempts to create a third type, “non-collateralised” or algorithmic stablecoins, the most well known of this type was Basis, which raised substantial funding from VCs and shuttered its doors last year, citing regulatory concerns.

BitShares

The first major attempt to create a stablecoin was a project by Dan Larimer –of Steem & EOS fame– launched in July 2014, called BitShares. BitShares was a multicoin system, which launched a native token with a fixed issuance and floating exchange rate (Bitshares, or BTS). These tokens could be locked up and used as collateral to create a second layer of token which sought to follow the price of any other asset, such as bitUSD, bitEUR, bitJPY, bitGold, etc… Due to problems in the design of these protocols, it has been noted on multiple occasions that they were unable to ‘hold their peg’ (i.e. bitUSD traded at prices substantially different from $1.00), and sometimes for extended periods.

Maker and DAI

An Ethereum-based project, Maker was initially launched in 2015, and nearly three years later the team launched their DAI stablecoin in December 2017. Like BitShares before it, DAI seeks to use crypto collateral to provide underlying value on which a Dollar stable token can be built. However, Maker departs from the Bitshares model by using other tokens to derive this value, namely Ether (Ethereum’s native currency), and in the future other more widely traded Ethereum based tokens (e.g., 0x, REP). If you’re interested in getting into the weeds, they maintain an interesting site with tons of data related to the underlying flows at https://mkr.tools/.

Tether

Perhaps the most well known fiat-backed token, and certainly the largest stablecoin, is Tether (or USDT). In addition to the well known USD token, Tether also offers a EUR token (EURT). Tether was initially named “Realcoin”, and issued its first tokens in October 2014, on the Bitcoin blockchain via the Omni protocol layer (previously known as Mastercoin). Tether states that “every tether is always backed 1-to-1, by traditional currency held in our reserves.” Tether remained a relative footnote for the cryptocurrency community until 2017, when the number of circulating Tethers exceeded $1 billion, eventually nearing $3 in mid 2018. Rumours that Tethers were being created without matching underlying deposits, an incident involving the theft of $31 million in Tether (which were later immobilised), and ties with the Bitfinex exchange all thrust this asset into the forefront of cryptocurrency discussions.

The Ethereum fiat-backed bunch: TUSD, PAX, USDC, GUSD

Partially due to the success of Tether, partially due to questions surrounding it, 2018 saw a flurry of activity on the Ethereum network to create tokens whose price sought to mimic that of $1.00. The first was TrueUSD (TUSD), launched by the TrustToken project in January 2018. TrueUSD aimed to conform to more rigorous procedures to reassure buyers that the appropriate deposits backing their token were in fact where they should be, and introduced controls for more effectively adhering to legal and regulatory rules, such as KYC and AML procedures. Soon thereafter the Paxos team launched “PAX”, Circle launched “USDC”, and the Winklevoss brother’s Gemini launched “GUSD”, all seeking to couple price stability with better attestation and regulatory conformity.

All this brings us back around the the JPM Coin (JPMC). While at first glance it may appear that JPMC competes with the likes of Tethers or the Ethereum fiat-backed stablecoins, for now it is only to be launched on a permissioned version of Quorum (a forked version of the Ethereum protocol with zero-knowledge proofs), and available for movements between accounts at JPMorgan. They have stated their desire to extend this to other “standard blockchains”, what exactly that means I do not know, but I’m curious to watch this project.

So why are people interested in stablecoins?

The allure is fairly clear, whether you intend to use cryptocurrencies for payments, building other products (such as prediction markets, loans or securities) having a unit of account that doesn’t regularly move up or down 10% per day is helpful. A majority of cited uses for stablecoins is holding them instead of more volatile cryptocurrencies during a market downturn, paying for good and services, and sending between cryptocurrency exchanges. Use cases in the Ethereum ecosystem largely focus on the more exotic “decentralised finance”, or “DeFi” uses such as decentralised exchanges (DEXs), prediction markets, and paying interest/coupons on securities tokens and peer-to-peer lending.

Whether this is a passing fad, or something more long term remains to be seen. And it is perhaps curious to see that a majority of these projects have been launched during cryptocurrency bear markets, and ironically worth mentioning that it was Ho Chi Minh who said it best:

“Remember that the storm is a good opportunity for the pine and the cypress to show their strength and their stability.”

If you’d like to understand more about the history of crypto collateral stablecoins (and non-collateralised stablecoins), Bitmex wrote a great piece last year.

Note: Nothing in this post should be construed as investment advice, legal advice, or a recommendation of any cryptocurrencies, particular project or crypto-asset.

Interested in reading more about cryptocurrencies? Read part one of our interview with Paul Gordon of Coinscrum here – where he talks about the early days of Bitcoin.