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Analysis: Just How Stable Are Stable Coins

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One month after regulators turned down a proposal for a cryptocurrency ETF by Cameron and Tyler Winklevoss, the owners of the Gemini digital asset exchange have won US regulatory approval to launch the first regulated stablecoin. The Gemini Dollar (GUSD) is entering a crowded market; dozens of stablecoins have launched over the last year. Stablecoins provide investors with the security of collateral by linking their value to another asset—the US dollar (Tether, Dai) or gold (DigixDAO, TrueUSD), for example—on a 1:1 ratio.

Stablecoins are a small nugget in the total market of cryptocurrencies being mined, but they are quickly growing market share. Among the top 100 cryptocurrencies by market capitalization, Tether ($2.7 billion), TrueUSD ($93.7 million), DigixDAO ($70.9 million) and Dai ($52.7 million) are rising in the ranks.

The Gemini Dollar is part of a new generation of secured coins seeking to provide investors with added security. Some stablecoins have been at the center of a controversy for not showing sufficient proof of collateral reserves. The new stablecoins are vying for investor attention by reducing collateral risk.

Steadying the Ship

The Winklevoss twins join other major investors in cryptocurrencies who have recently launched stablecoins as a way of lowering volatility and driving mainstream acceptance of digital coins. High volatility is preventing the wide-scale adoption of cryptocurrencies as a store of value or medium of exchange.

Backers of stablecoins include some of the largest cryptocurrency exchanges and investment funds. Binance Labs, OKEx, Huobi Capital, and Dunamu & Partners—the venture capital arms of major cryptocurrency exchanges—are behind Terra. Reserve (RSRV) is backed by PayPal co-founder Peter Thiel and U.S. crypto exchange Coinbase. In Asia, founders of the $1.5 billion Xiongan Global Blockchain Innovation Fund are financing a Japanese-Yen-backed stablecoin being launched by GrandShores Technology Group.

Within 12–24 months, these secured coins could serve as a heavily weighted anchor for the volatile cryptocurrency market. If stablecoins fail to back their reserves one-to-one with investor dollars, however, they could destabilize the entire crypto market.

Where are the investors’ dollars?  

The Gemini Dollar addresses the major risk and criticism of current stablecoins, and that is a lack of auditability proving the existence of the collateral reserves. The audit of Tether’s US dollar reserves has been the most controversial issue surrounding stablecoins. The cryptocurrency that equals 47 percent of the money inflow into Bitcoin has only recently published an audit, by a law firm, not an accounting firm.

Accusations that Tether could not possibly have all the reserves, however, stem from a lack of understanding of how Tether operates. The cryptocurrency is in effect self-funding. When an investor places an order with an exchange, Tether prints the digital currency to fulfill the order. The Gemini Dollar will also be minted on demand.

Nonetheless, Tether will require an accounting audit to fully win the public’s trust. The trustless blockchain can confirm the existence of stablecoins, which can be tracked and audited on the immutable digital ledger. But stablecoins also need to instill trust by proving the collateral—US dollars in most cases—exists.

New stablecoins are addressing this shortcoming. As part of its ‘network of trust’ with licensed financial institutions and auditors, Gemini plans to use a US public auditing firm to verify proof of solvency.

GUSD reserves are audited monthly by a licensed accounting firm and the report published on its website. Additionally, the reserves are held by regulated custodians and federally insured. These measures are lowering  the collateral risk and setting new standards for stablecoins. Proper auditing, custody, and insurance arrangements were significant factors when IBM recently chose to use the StrongHold USD-pegged stablecoin in trials with large enterprises. The stablecoin for financial services provider Rockz is also audited monthly to ensure investors it has the required Swiss Franc holdings.

Asset Collateral and Diversification

Not wanting to put all their eggs in one basket, some stablecoins are diversifying beyond the US dollar as collateral. Still fresh in the minds of many are the US dollar devaluations and speculative attacks that led to the end of the US dollar peg to foreign currencies in the 1970s. Terra plans to link to a basket of currencies (Euro, UK Pound, US dollar, Japanese Yen, Chinese Yuan), and eventually commodities (gold, corn, oil). Switzerland’s no fee X8 Currency is backed by a basket of fiat currencies and physical gold.

Crypto assets are also being used as collateral. To secure DAO Maker’s Dai, a stablecoin with a value of 1 USD could be loaned out in exchange for 2 ETH deposited into a smart contract. Reserve is backed by a pool of crypto assets, without the use of debt, and shares in future growth that can be bought with stablecoins to control supply.

Other stablecoins are developing alternatives to currency pegs as reserves. Terra is using the transaction fees from dApps run by e-commerce members with a collective $15 billion in annual revenues to create a Stability Reserve. Changes to the money supply are determined by a fluctuating exchange rate band mechanism rather than demand for tokens. Because the transaction fees are generated from the productive dApps economies, the reserve is not subject to speculative attacks.

Commerce-Ready Blockchains

Stablecoins could provide many advantages as the future currency of global commercial transactions owing to their ability to offset both fiat and cryptocurrency volatility. To be used in commercial applications, however, they require higher throughput.

The use of the Ethereum blockchain by the Gemini Dollar, an ECR-20 token transferrable across the Ethereum network, involves a tradeoff between performance and cross-chain dApps compatibility.  The planned upgrade of Ethereum, which hosts more than 90 percent of blockchain dApps, is anxiously awaited.

Tether has demonstrated the ability to handle robust transaction demands on the Omni Layer, an upgrade of the Bitcoin blockchain. Other networks are emerging for business applications. Another key attraction for IBM was Stronghold’s operation on the Stellar blockchain, a leader in speed and scalability performance. Very low transactions costs make this multi-currency blockchain appealing to large-scale business applications.

Considering collateral risk, diversification and auditability can help investors choose among the growing choice of stablecoins. As these collateralized coins compete for a place on major exchanges, exchange concentration should also be evaluated. The Gemini Dollar has announced its listing on three exchanges, including two in the top 10 by volume, Bibox and HitBTC. Tether also trades on top exchanges, although a recent study showed it posed concentration risk, and thus systemic risk—the risk that its failure could cause other crypto economies to fail. A recent analysis conducted by Blockspur showed that the high transaction volume in Tether on the Huobi exchange involved the same receiver. Wealth concentration raised another red flag. Ninety percent of Tether supply is owned by the top 0.2 percent of traders.[1]

The prudent investor will ensure these virtual coins are worth the metal they claim to be backed by.




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