What role will stablecoins play in the financial market of the future?

Cryptocurrencies offer a range of benefits. One of the most important is that no intermediary institution is required as an intermediary. Payments can be sent by anyone to any corner of the world simply and quickly than ever before. A decisive disadvantage, however, is that cryptocurrencies are often subject to strong price fluctuations. They are therefore less suitable for normal everyday use. In order to be able to manage their livelihoods securely, people must rely on the fact that their money and its value will remain stable in the long term.

Digital currencies for the 21st century — Central Bank digital currency or stablecoins?

How can you integrate the benefits of a cryptocurrency into the established monetary system? Digital central bank money, so-called CBDCs (Central Bank Digital Currency), is intended to remedy uncertainties caused by excessive currency fluctuations. In addition to physical money (fiat money), nation states or associations of states such as the EU want to establish a purely digital means of payment as an additional standard. A national or EU digital currency issued and managed directly by central banks could make payments easier, faster and cheaper.

Central banks are thus competing with private providers such as Bitfinex (or Tether Limited) with the stablecoin Tether. Bitfinex is already offering blockchain-based stablecoins that bring stability to the volatile crypto financial market. They achieve this by being pegged to a fiat currency such as the US dollar. There are also stablecoins backed by other cryptocurrencies. In doing so, a user deposits cryptocurrencies, which are technically blocked from access. With the help of smart contracts, this is ensured that the user has deposited security in the form of a cryptocurrency. New 'minted' stablecoins are then loaned to the user, as an example the Maker (Dai).

Stablecoins are used as a means to bridge the gap between crypto and fiat currencies when investing. The demand for a stablecoin when physically deposited also increases demand for the underlying asset, in most cases the US dollar. Influence on the foreign exchange market is currently only based on trading, staking or token sales. Only through use such as Facebook's Diem would there also be real economic influence on the foreign exchange market.

Overview — the most popular stablecoins

There are currently just under 200 stablecoin projects. The best known are:

Tether (USDT) — Originally launched in 2014 under the name Realcoin, making it the oldest stablecoin. In addition, it is one of the most popular and valuable. Tether exists on many different blockchains.

TrueUSD (TUSD) — Launched in January 2018, pegged 1:1 to the US dollar, 400 million 'secured' tokens were in circulation by October 2020. TUSD is available on the Ethereum blockchain and the Binance blockchain.

USD Coin (USDC) — Launched in 2018, also known as the USDC ticker, pegged 1:1 to the US dollar, second-largest stablecoin in terms of market capitalization.

Diem (formerly Libra) — originally planned by Facebook as a new digital currency, several cryptocurrencies are now to be created, each secured in the respective national currency. Diem was supposed to be launched at the beginning of 2021, but it's still a long way off.

Digital yuan — The digital state currency of the Chinese central bank is currently undergoing a test run with payout at an ATM. For now, the test runs are limited to developed cities and metropolitan areas.

Opportunities and risks of stablecoins using Tether as an example

Until the end of the 20th century, there was a gold standard for currency systems. In the gold standard, there was a connection with gold as the main factor until this former principle was cashed in by President Nixon in 1973. Stablecoins have similarities to the former principle, albeit in conjunction with the US dollar as the main factor.
The aim is to build a bond with stablecoins in order to inhibit volatility in the crypto market. An asset as a reserve secures the value of the stablecoin.

For example, $1 million is deposited and the equivalent of $1 million digital stablecoins are issued. In theory, a user can now redeem a unit of stablecoin for a unit of the asset that secures it. An asset can be fiat, precious metal, cryptocurrency or another tangible asset.

For example, the original stablecoin Tether is pegged to the USD. Tether should actually be used to move money quickly between exchanges. The main reason for this was the use of arbitrage opportunities, i.e. minimizing the risk of loss in financial speculation. This should avoid the market volatility that applies to BTC and other crypto assets.

However, Tether was quickly used, for example, to move money across national borders — not always legally. So Chinese importers sent millions of dollars to China via Russia, although there are strict capital controls in China for this. These were thus circumvented thanks to the technical capabilities of stablecoin.

Tether, or the operator Bitfinex, is also under criticism for other dubious practices such as price manipulation. Bitfinex and Tether are also said to have tried to cover up liquidity bottlenecks through unfair measures. Bitfinex has not disclosed which real reserves exist or has not yet published an audit of its reserves. The settlement with New York Attorney General Letitia James was finally reached in February 2021 a payment of 18.5 million set for settlement. In addition, all trading activities have been prohibited in New York ever since.

Stablecoins are only suitable for unproblematic use to a limited extent, as extended technical know-how is required. Not all Tether is the same — the coin exists on different blockchains. Inexperienced users can get confused when sending Tether tokens, so that their money is lost when sending to the wrong wallet.

How stable are stablecoins really?

Stablecoins are no guarantee of wealth protection; they are just as dependent on national or global diplomacy and fundamental power shifts in the political, economic or social sector as any other currency. As a result of sanctions or changes in government, budget debates or a change in monetary policy, there is also a risk of fluctuations in value due to ties to key currencies. Basically, the stablecoin will be as stable as the asset that secures it.

In addition, there are some issues that specifically affect stablecoins. One of them — as already mentioned in the Tether example — is the lack of transparency about which reserves exist and where these reserves are held. This becomes particularly problematic when the issuer of a stablecoin does not have a license. In the worst case scenario, the stablecoin could be frozen by the responsible supervisory authority. Due to the lack of transparency, it is also incomprehensible whether each stablecoin can be redeemed for a real value at the end, or whether the reserve is actually smaller.

Conclusion: Clear, comprehensible rules for digital currencies instead of the Wild West style

Stablecoins started out as an innovation, but over the years have become entangled in contradictions that severely scratch the image and credibility. However, these facts are also no new unknowns. On the contrary, these are problems that existing currencies are also struggling with. However, there is still mistrust in any currency alternative that does not deliver what it promises.

Using the example of the USD Coin (USDC), it becomes clear that the American law enforcement agency is keeping a backdoor open in stablecoin: The USDC can be frozen at the request of the law enforcement authority. However, this contradicts the credo of blockchain “without intermediaries” and also without the direct influence of third parties, such as governments.

But how realistic is this claim? Wouldn't it be precisely these control mechanisms that contribute to the acceptance of stablecoins? Have the issues of deposit insurance, liability, data protection and control not become essential in our society?

A Wild West style doesn't work for mass use. Every technology, however innovative, needs to be linked to law and order, because that is our requirement for a functioning currency. The consumer relies on deposit insurance and makes claims for liability and, if applicable, compensation.

If the value of our 10 euro note were to adjust, both positively and negatively, acceptance of and trust in the euro would be massively weakened. Yes, the euro is also subject to fluctuations. Yet this is supported by certain mechanisms, so that we have had similar inflation and monetary value for many years.

There will be advantages and disadvantages when the first Central Bank Digital Currencies are implemented and used. This will show how far central banks' influence on the design and implementation of substitute digital currencies must be in order to guarantee stability and trust.