The main problem experienced nowadays when dealing with cryptocurrencies is the high level of volatility most coins carry. Cases of flash crashes are common while prices of even the most popular coins sway by double-digit percentages within hours. This creates an unreliability which makes cons unreliable as a method of payment. But what if there was a way to make the value of coins more stable similar to fiat currency or commodities such as gold?
A pertinent example of such a system would be Facebook’s Libra. From the project’s whitepaper, The Libra Association will purchase real-world assets to back every Libra token, essentially tying the coin to stable assets and subsequently making the price of Libra stable. This is the idea behind most stablecoins available today. The question then becomes whether these stablecoins are the solution to all problems experienced by coin holders, and which are the most secure stablecoins to purchase in 2020. (Before starting to invest in 2020: Find Out More About Tezos and Its Price Prediction For 2020)
History of stablecoins
The first stablecoin that became available in the market was Tether (USDT) back in 2014, after it was renamed from Realcoin. The idea, though, was first proposed in 2012 by J. R. Willett after noting that cryptocurrencies had a lot of volatility. When Tether was launched, the founders claimed that each token was backed by actual currency. This was meant to ensure stability in prices since tokens were backed by US dollars, euros and Japanese yen. Therefore, the coin’s value would not change regardless of the withdrawals/deposits made. To this date, the value of USDT tokens has remained around $1 as promised. (Check out: UNUS SED LEO Price Prediction 2020)
Following the success of Tether, it was only natural to expect more players to enter the game… which they did. By the end of 2017, there were only a few stablecoins around despite the boom in coin prices, but today the number has risen significantly. Blockchain, a crypto research firm reported that there are 54 stablecoins active today and these comprise 2.7% of the total crypto market cap. Of these, 83% are backed by real world assets while the rest (17%) are algorithmic. More on this later.
Why are stablecoins so attractive?
In October 2019, the Bank for International Settlements (BIS) published a report that stated Bitcoin had failed as an “attractive means of payment or store of value”. This was supposedly due to the high volatility users experience on a day to day basis that makes it difficult to depend on the coin as legal tender. Imagine you ran a business and agreed to accept, say, Bitcoin, as payment. One day, one coin could be worth $10,000 and the next it could be worth $7,500. To keep up with these fluctuations, you would either have to change your prices continuously or swallow any losses. This is what makes coins so unsuitable as a means of payment and why stablecoins may be the solution. (Learn the: 5 tips to forming the most promising coin investment portfolio)
Because stablecoins are pegged to a stable asset, their value does not change. A good example is Tether, which has always been valued at about $1 after being pegged to the US dollar. As a result, businesses can rely on such coins for payment because both the business owners and customers know what to expect. Apart from being favourable for payments, stablecoins are also great for global remittances because transfer of tokens is much faster. (Does BTC Stand A Chance Of Becoming The Worldwide currency?)
Finally, stability in value makes stablecoins attractive to investors without the risk of flash crashes or crypto exchange runs. Flash crashes are very common and they often occur when a major investor making a huge withdrawal or deposit. This problem cannot happen with stablecoins. Crypto exchanges are also prone to runs that cause services to become low or shut down completely, which happened severally back in 2017. This too cannot happen because stablecoins cannot lead to the same issue. (Do you know: What is An ICO and How Can I Make Money On It?)
Stablecoins have had some very popular proponents including Vitalik Buterin and the Winklevoss Twins. Both of them see stablecoins as a solution to many coins’ problems and the future of the crypto market. Indeed, stablecoins can be used as a go-between by traders, investors and users to convert between different coins, which would create an extensive crypto arena.
Are there any downsides?
As with most things, the benefits come with drawbacks, and stablecoins are no different. The main problem with stablecoins unfortunately is the reliance and trust everyone has to have on a single entity. When investors buy stablecoins, they have to trust that the company issuing the coin actually has every token backed up by actual assets and it is not just a ruse. Tether is once again a good example of this after several experts questioned that all USDT tokens were backed by actual assets. Even the office of New York State’s Attorney General posed the same questions and launched an inquiry to the matter. (Find out: What is Huobi Coin and its Price Prediction for 2020?)
In response, Tether still insists that all tokens are backed by assets and noted that a paper by John Griffin, Professor of Finance at the University of Texas, Austin, back in April 2019 was flawed. On November 7, 2019, Tether published a statement claiming that Griffin’s paper analysed a block explorer to determine Tether had $2.1 billion in assets and 2.8 billion USDT tokens in the market at that time. The company’s general counsel Stuart Hoegner said that the paper was flawed because it only took note of some assets but not the company’s aggregate reserves. (Gram (TON) Vs BTC in 2019: Best Worldwide Crypto Fight, Pros and Cons)
Investors in Tether simply have to trust that the company is telling the truth because there is no way to definitively determine if all USDT are fully backed by actual assets. Add to that, this makes stablecoins centralized unlike actual coins that are decentralized. The problem is not only that this goes against the idea of cryptocurrencies, but also these companies have to adhere to regulations. For starters, the companies must gain regulatory approval to operate in some regions. This means following regulations such as KYC (know your customer) and AML (anti money laundering), both of which take away anonymity and privacy. Should such a company go against the regulations, all assets could be frozen along with the investors’ tokens.
Being stable also takes away the ability of speculators from trading and making a profit. Looking back at 2017, the value of Ethereum rose by 14,000% between January 13, 2017 and January 13, 2018. At the same time, Tether always remained valued $1 despite market capitalization rising significantly. This illustrates that there is no profitability to be gained from investing in stablecoins.
Which are the best stablecoins around?
You must be anxious to get to the point and learn about the best stablecoins so that you can start buying them. However, it would be better if you took some more time to learn some technical stuff about stablecoins before rushing to buy them. Not only will this help you choose more wisely, but you will also know exactly what you’re getting yourself into.
How stablecoins work
Stablecoins work based on the 17th century quantity theory of money. This theory states that: money supply (M) multiplied by velocity of circulation (V) equals price level (P) multiplied by transaction volume (T) – M x V = P x T.
Imagine a stablecoin whose demand suddenly doubles, this would mean that the velocity of circulation (V) would double. For the equation to remain balanced, the price level (P) would normally rise as well. In the case of stablecoins, though, the company issuing the coin would artificially lower money supply (M) so that the price level (P) remains the same. This can be done in two ways:
Asset backed stablecoins
This is the most common type of stablecoin because each token is backed by actual assets in the real world. Tokens like USDT are backed by fiat currency in euro, US dollars and Chinese renminbi while Libra is supposed to be backed by assets such as bonds, stocks, etc. These stablecoins derive their stability from the underlying asset so that the two can be exchanged without affecting the overall value of the token.
That being said, there are still some sceptics who believe that fiat currencies are also not stable as they are only backed by central banks and governments. Cases of hyperinflation in economies such as Zimbabwe and Venezuela are proof that fiat currencies are not really stable as they can still be controlled unlike assets like gold. This is why some countries such as Venezuela propose launching a coin backed by oil (Petro), which is the country’s main export.
Crypto backed stablecoins
It may seem counterintuitive to back a stable asset against a volatile asset, but these stablecoins somehow manage to do it. An example of this is the DAI token by Maker DAO. This is achieved by Maker DAO purchasing ether tokens and creating DAI tokens on a 1:1 ratio. For additional security, a security pledge is put in place by the company that guarantees a payout on a ratio higher than 1:1 against the collateral currency.
For those feeling insecure about the concept of backing from fiat currencies and somewhat volatile assets, algorithmic stablecoins are the solution. These are similar to asset backed stablecoins, but no assets are actually bought. A company can choose to peg the value of a stablecoin to the US dollar, and then create an algorithm that regulates the supply of tokens to match the value of the dollar. When demand for the coin is high, the number of coins is artificially increased and with higher supply, value of individual tokens drops.
How to evaluate stablecoins
If you want to buy some stablecoins, there are various factors to consider so that you can choose the best one. The most important of these factors is the security of your money and the tokens since stablecoins are not good for short-term investment. To establish security, consider how the token is collateralized and how transparent the company is. Most stablecoins are backed by real assets, but even this is subject to the company’s transparency. As the largest stablecoin by market cap, it is no surprise that investors have been worried whether USDT tokens are fully backed by assets.
In January 2018, the company dismissed its relationship with audit firm Friedman LLP, further casting doubt on whether it actually has those assets. Later on, Tether would produce a letter from Deltec Bank and Trust Limited based in the Bahamas to confirm that it really had the assets it claimed. Despite these doubts, at least Tether is open about its ledgers and it is possible to see crypto assets owned by the company. If you are considering an investment in another stablecoin, it is essential to know how secure the company is and whether the tokens are backed or not.
Investing in these stable coins also carries some additional costs since the company uses funds to maintain the network and purchase assets. In most cases, these charges are relatively low and affordable, but it doesn’t hurt to be extra cautious and check for specifics. Some companies even have a lockup period within which you are not able to withdraw your investment, just as with most hedge funds. Before making that deposit, therefore, be sure to consider a lot of factors about that company and the token itself.
Top stablecoins for 2020
Now that you are knowledgeable about stablecoins and everything to do with them, it’s time to look at some examples you can invest in today. As there are over 50 different coins, we chose to focus on just the top 5 that you can introduce to your portfolio come the new year.
This one may be a bit on the nose, but there is no way of mentioning stablecoins without mentioning Tether. It was the first stablecoin to be launched and it is still the king of stablecoins, having a market cap of over $4 billion at the moment of publication.
The Wall Street Journal reports that 80% of all Bitcoin trading is done using USDT, which keeps the liquidity high. In financial markets, nothing is as important as investor sentiment. Tether has got loads of this, which is how the coin has been able to survive despite all the controversy surrounding it. As far as security goes, this is perhaps the most secure stablecoin around. Not only is it stable, but it is also the most commonly offered token being available on most crypto exchanges in the world.
This is what you need from a stablecoin because you may, at some point, need to transfer your coins from one exchange to another. USDT has thus become a popular coin to which you can convert a myriad coins and transfer them out of an exchange at once. It is also preferred when you need to convert your investment from one coin to another, whereby the coins can be converted to Tether first without having to convert to fiat, which is costly and slow.
The second most popular stablecoin was launched in 2018 with one goal in mind - transparency. After noting the problems facing investors in Tether, TrueUSD was created to create a similar token that would be more transparent and improve users’ trust. It is similar to USDT because it is also pegged to the US dollar, keeping the token’s value consistently at $1. Unlike Tether, though, this company agreed to an independent audit to check the company’s aggregate assets, which was found to be true. All TUSD tokens are backed by US dollars stored in escrow accounts with trusted banks.
To acquire TrueUSD tokens, you are required to first pass KYC/AML checks and then send your funds in USD to the company’s account with an escrow agreement. When the funds are received, a smart contract is initiated that sends TUSD tokens to your Ethereum address. Since the tokens are based on the ERC20 structure, they can be stored in any compatible wallet. Withdrawals are similar, where the TUSD tokens are sent to the escrow bank, which subsequently sends fiat equivalent to your tokens.
Thanks to the trust you can put in TrueUSD by TrustToken, this is definitely one of the stablecoins to consider in 2020 as pressure keeps mounting against Tether. Should Tether be found in violation of any laws, you can bet that investors will flock to this coin instead. Even though this won’t result in an increase in price, it means that liquidity is high to ensure fast transaction speeds and security of funds even on the long term.
Maker DAO (DAI)
Although the subtopic is about the DAI from maker DAO, this product still doesn’t technically exist. Maker DAO had the idea to create a stablecoin that would not be pegged to any asset but rather controlled by algorithms. The initial launch was called the Single-Collateral DAI (SAI), which is the currently available stablecoin ranked 56th on CoinMarketCap.
This stablecoin works by letting algorithms regulate the supply and price of SAI so that it remains pegged to the USD on a 1:1 ratio. So, when demand for SAI rises, the algorithm automatically creates new tokens that increase supply and lower prices back to $1. On the other hand, decreased supply leads to the destruction of tokens to lower supply and increase the price. By December, Maker DAO expects to upgrade the token to a Multi-Collateral DAI (DAI) while understanding that the timeline may be extended further based on unforeseen circumstances.
The DAI is also an ERC20 token, meaning that it can be stored in any compatible wallet. Being a crypto-based stablecoin also increases transparency because it is possible to track all tokens and confirm that all tokens really are backed up. With the Multi-Collateral DAI, users will be able to choose whichever asset they are most comfortable with as a backing for their tokens. It is already available on some of the most popular exchanges, and this is a good sign that investors are already confident in the technology, making this a worthwhile candidate for investment in 2020.
USD Coin (USDC)
This is yet another stablecoin that is backed by fiat currency in US dollars. Just like TrueUSD, USD Coin is also transparent and is actually ranked higher than the former at number 24. Transparency is ensured by the auditor Grant Thorton LLP that conducts monthly audits to prove that the company does indeed hold the said US dollar reserves as there are USDC tokens. Furthermore, a network of bank accounts are used to hold the company’s US dollar reserves, and these bank accounts cannot be accessed by the company, leaving the funds only for backing tokens. Banks holding the company’s reserves are required to regularly disclose the amount of money they hold in reserves to increase transparency even further.
This coin was launched in 2018 from contributions by Circle and Coinbase that created the company CIRCLE. These companies prove to investors that the coin can be trusted, also considering that all banks partnered with CIRCLE are licensed and regulated. For these reasons, USD Coin is one of the most secure stablecoins in 2020.
Paxos Standard Token (PAX)
Also launched in 2018, Paxos is chartered by the New York State Department of Financial Services. It has an office in New York, but also in Singapore and London. The company is advertised as a company that enables ‘movement between physical and digital assets’. This is made possible through an extensive ecosystem with various products, starting with Paxos Standard Token (PAX). This is similar to USDC, USDT and TUSD and is managed by Paxos Trust Company to ensure all tokens are backed by US dollars. Since it is a regulated company, the transparency is obvious and trust is increased compared to USDT.
Another token is PAX Gold, which is pegged to the value of gold rather than the US dollar. This is more suited for long-term investors who would like to invest in the value appreciation of gold. Alternatively, investors can also purchase the Binance USD coin (BUSD), which acts like the Paxos Standard Token but is meant for use on the Binance Exchange. There are several other services from Paxos such as itBit, which is a coin exchange for trading coins.
For investors, PAX and the rest including BUSD and PAXG are all very secure, especially for traders in the US who want to keep their investment secure.
All the above are great stablecoins to consider buying in 2020, but there is no need to buy several coins. To find out which one is the best, watch this video that will help you decide: