The perfect balance - how stablecoins are tackling crypto price volatility

. 4 min read

Cryptocurrency and distributed ledgers are the future for the global economy, for me and many others there is no longer cause to doubt this. The writing is on the wall for centralized sovereign-based stores of wealth, and it’s only a matter of time before the paradigm shift occurs.

But right now in the very earliest stages of the transition, there are many complications. We want to drive mass adoption of crypto and promote broad consumer acceptability, however along with the technological obstacles to this, there is one massive problem - pricing stability. When measured against fiat currencies, all cryptos - even the bitcoin, the granddaddy of them all - are incredibly unstable in value. So they are difficult to use.

This has nothing to do with philosophy or outlook, simply the hard fact that most of the world still uses and transacts in sovereign currencies. There are people such as Andreas Antonopolous who indicate they now earn and live almost entirely within the crypto ecosystem, and projects to create entirely crypto-based communities, but most of us still live with at least one foot firmly based in the fiat world. At my agency BlockSparks, we are happy to accept payment for all our services in a range of cryptos - but we quote and price at prevailing US dollar rates - for the simple reason that our consultants cannot pay their mortgages in BTC or ETH, and they need to know how much they are earning each month.

As new cryptocurrencies explode on the ecosystem daily to tackle the myriad challenges associated with the main incumbents, stablecoins are taking their place in the mix, along with those specifically designed to take on privacy, speed and other problems. Stablecoins offer many advantages within the crypto space, not least to traders, who want to take advantage of the rapid shifts in the price of coins without moving their investment in and out of crypto altogether, with all the costs and lead-times involved there. In many countries too transactions are taxed quite differently depending on whether you move funds out of crypto into fiat, versus trading one coin for another.

Stablecoins have a unique challenge though, because for any currency to have stability, it needs to be pegged to something specific as collateral (Or have controls on its marketcap and distribution, in the way that reserve banking stabilizes the values of fiat currencies by adjusting the amount of currency in circulation).

One of the largest contenders to have emerged in this market is Tether, whose USDT token is, as the abbreviation implies, pegged to the US dollar - and collateralized in the same way, i.e. they hold in reserve fiat funds of $1 per token issued, to balance the counterparty risk that some/every token-holder could claim that redemption and cash out.

Or do they? There have been allegations that Tether is under-collateralized, and as they parted company with their auditors earlier this year, no one really knows. With their close associations with the exchange Bitfinex, Tether has very rapidly come to provide a great deal of liquidity to the crypto marketplace overall, and no one wants to spread FUD. It’s also worth remembering that 100% collateralization is a far higher liquidity standard to be held to than any fractional reserve bank has to manage.

The price of the USDT token has remained relatively stable, between $0.8 and $1.1, so it’s basically fulfilling its promise as a stablecoin - if not exactly true to Satoshi Nakamoto’s original vision of “a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”, because being backed by the US dollar, it’s effectively backed by a large deposit account of said dollars - and as such is vulnerable to governmental interference, changing banking laws, and other financial regulations.

So newer solutions seek to address stability in other ways, such as collateralizing wholly within the crypto ecosystem. Havven is one such coin, recently added to the ‘stable’ (sorry!) of currencies that LocalCoinSwap will have tradeable at launch.

The challenge of course is that any crypto is volatile, so to create a crypto-backed stablecoin, over-collateralization is needed - just to protect against price fluctuations. And you also need to consider the day-to-day use of the token, vs it’s importance as a store of value - liquidity vs stability. It’s a complicated problem to tackle.

Havven address this via a dual-token model, where the Havven token holders can issue Nomin tokens worth 20% of their Havven holdings (over-collateralizing by a factor of 5, effectively). In exchange for this staking they receive a portion of the transaction fees, and the Nomins are used in the marketplace.

So, all Havven owners earn Nomins, and the more Havvens someone has, then the more Nomins they will earn. Havvens and Nomins work collectively to give each other value. More people using Nomins means more transaction fees in the network, which means Havvens become more valuable, as they pay higher dividends to their holders.

The value of the Nomin is essentially stabilized by a "distributed collateral pool" - before Nomins can be issued, people need to lock away enough Havvens into the escrow staking account. The system is designed to ensure that the total value of Havvens in the collateral pool is always worth more than the value of Nomins in circulation, providing a unique solution to the underwriting problem, which is fully independent of the US dollar or any other sovereign currency.

Of course these are not the only two models for stablecoins, and this is an emergent area of cryptocurrency development we will all be keeping an eye on. Stablecoins are going to be pivotal in driving mass adoption, because no one can pay for a round of drinks or a round of employee salaries in a currency which they do not have some idea of the value of - today, tomorrow and in the future.

And the future is where we’re all looking to. Perhaps as the crypto-economy continues to grow, volatility will naturally settle out (along with the number of competing coins/tokens), simply due to inertia and consensus.

But until that time, stablecoins are likely to play an important role in managing costs and pricing - so we’ll be watching to see how they continue to play out in the marketplace, and keeping an eye on new developments as they emerge.