Stablecoins - Not So Stable
Enough has been said about the extreme volatility of cryptocurrencies and how it hinders the broader real-world adoption of cryptocurrencies. Bitcoin’s store-of-value and uncensorable medium-of-exchange propositions are vastly undermined by its huge price swings. Any asset that fluctuates by 20% in a single day cannot become a reliable instrument for either of the aforementioned value propositions. According to a few cryptocurrency maximalists, the extreme volatility of cryptocurrencies can be attributed to the speculative nature of the asset class and that the volatility will subside once investors understand the inarguable benefits of the utility aspects of cryptocurrencies. On the other side, crypto detractors posit that the high fluctuations in crypto asset prices will never lead to the real-life adoption of cryptocurrencies. It’s a chicken-and-egg problem here. More adoption curbs volatility and high volatility curbs adoption.
This is why stablecoins
are important. To drive real-life adoption of cryptocurrencies, new users need to interface with the crypto world through a price-stable cryptocurrency (Stablecoins). Stablecoins are cryptocurrencies whose value is pegged to the value of a different asset (mostly USD, but gold-pegged
stablecoins are also in existence). For USD-pegged stablecoins, the theoretical price of the stablecoin is always $1. The price-stability offered by stablecoins reduces the friction to onboard new users through decentralized applications such as prediction markets, blockchain-based loans, etc. Despite the many benefits of stablecoins, there are dangers to consider.
The biggest risk for stablecoins comes from the fact that their value is pegged to the value of a different asset. This is in many ways similar to how emerging economies peg the value of their national currency to USD or EUR to provide exchange rate stability for importers and exporters. History shows us that currency pegs are hard to maintain and when the peg breaks, all hell breaks loose and it creates a downward spiral of value destruction. As anyone that has heard of George Soros will tell you, hedge fund managers can be destructively ruthless
sometimes. Soros was heavily influential in breaking the pegs of national currencies in 90s, which subsequently resulted in significant devaluations of local currencies (GBP and Rupiah are cases-in-point). Central banks of meaningful sizes were unable to fend off the attacks of speculators on their currencies. We are not sure how thinly funded cryptocurrency projects can withstand a full-blown onslaught by a big speculator.
In our upcoming blog post, we aim to provide a deep dive into the taxonomy of stablecoins and how they actually function, in addition to the structural risks in their operating models.
Team ZenPriveX is in Singapore this week for the inaugural edition of Consensus Singapore. We hope to come back to with you key takeaways from the event and other interesting things we pick from around conference in Singapore in a newsletter soon. You can read about our Consensus New York round-up here.
Please hit us up if you are in Singapore this week.