A “stablecoin” is defined by Investopedia as “a new class of cryptocurrencies which offer price stability and/or are backed by reserve asset(s).”
The point of – or perhaps the hope for – stablecoins is right there in its name: to stabilize an otherwise shaky e-money market.
These new cryptocurrencies are linked or “pegged” price wise to real-world, mostly mainstream assets like the U.S. Dollar, E.U. Euro or even hard money reserves like gold.
According to a recent report from the company Blockchain, there are two types of stablecoins: reserve-backed and algorithmic.
The first type, reserve-backed, works “a little like paper money used to when it was linked to the gold standard,” as Business Insider puts it. Coins of this variety are backed one-to-one by reserves of the dollar, euro or other assets. This has been understood to mean that there is an actual $1 bill, 1€ bill or another physical piece of money sitting in a bank account for every stablecoin issued. (Note: There are still some questions surrounding this claim, at least as far as the stablecoin giant, Tether, is concerned.)
Nevertheless, consumer confidence in the fact that their stablecoins can be exchanged for physical pieces of money is what has maintained the cryptocurrencies' price pegs, and what will most likely continue to, do so.
The second type of stablecoin is what’s known as “algorithmic.” This version is not backed by any reserves, but instead, is controlled quantity wise by an algorithm that adjusts the number of stablecoin tokens available in tandem with consumer demand. As demand goes up, so too do quantities of the tokens and vice versa. As Garrick Hileman, Blockchain's head of research and author of the company's stablecoin report told Business Insider, this supply-and-demand-based quantity control is to ensure “there’s not an appreciation in the value of the stablecoin.”
Hileman goes on to note that this second algorithmic type of stablecoin is “much more challenging to design” given the unproven performance of it so far.
Aside from being backed by a tangible form of money, how else are stablecoins strengthening the cryptocurrency industry as a whole?
Well, for one, they give crypto exchanges a leg on which to stand. Fearing unforeseen or not-yet-established understandings of what could constitute compliance violations, many banks have been pretty wary of touching any piece of the mostly unregulated cryptocurrency market so far. Without consistent lines of access to mainstream monies, the exchange apparatus of the cryptocurrency market has seemingly been, in large part, non-existent. Stablecoins have paved a path for crypto exchanges to get back in the game, at least in part, by offering access to a recognized form of money for which to exchange crypto tokens.
Many also see stablecoins as a gateway for expanding the blockchain technology to other sectors such as insurance, loans, and smart contract dividend payments. Some even think – or perhaps hope – that this potential broadening applicability of the blockchain, and now, stablecoin technology means an opportunity for a vast market with room for many companies to grow and innovate further.
The stablecoin concept has also attracted significant amounts of venture capital, with Blockchain’s report noting that “$350m in venture funding has been raised by all stablecoin project teams to date.” Additionally, Blockchain states that at the time of their research there were over 50 active stablecoin projects in the works globally.
Great, so stablecoins are more widely attractive and perhaps even more legitimate than their former crypto brethren, but what does that mean for you and your gold investments?
While it’s still unclear what, if any, impact stablecoins have or will have on gold prices, there a few things we thought were notable.
First, according to Blockchain’s report and based on a recent 60-day-performance comparison of cryptocurrencies, fiat money (USD and EUR) and gold (see below graphic), the cryptocurrency category “is likely to remain more volatile than well-managed national currencies, as well as physical commodities like the one it is most frequently compared to, gold,” at least for the “foreseeable future.”
Source: Blockchain’s “The State of Stablecoins” Report, 2018.
While the graphic clearly shows much higher volatility in the crypto sector, there is a “growing class of ‘price-stabilized’ cryptocurrencies backed by physical commodities” like gold, the report points out.
One such example is Digix (DGX), a stablecoin described as “digital gold on a blockchain.” In short, it’s a virtual representation of a gold investment equating to one gram of gold for each stablecoin token. This 1:1 ratio also seems to be the case with most other gold-backed stablecoins we found.
Even though the majority of stablecoins are still those pegged to, and therefore backed by, fiat currencies, the “growing class” of those tethered to gold is, at the very least, an exciting trend.
According to Digix’s website, they are “democratis[ing] access to gold” by creating “a world where the finest gold bars are made divisible and transferable on the blockchain.” Their stablecoin “tokens” are backed by “99.99% gold cast bars from London Bullion Market Association-approved refiners.”
Does this mean we’re heading back to the gold standard?
Only time will tell.
While stablecoins are still very much an infant market with many years – or at least phases – of development to come, the trend toward consumer demand of investments backed by physical reserves is a notable point.
At the very least, it’s clear that consumers seem to be increasingly wary of “speculative investments,” as many earlier-phase cryptocurrencies have come to be regarded (meaning those not backed by reserves or whose quantities aren’t controlled). It’s clear that price swings of 5% to 10% or even 20% on an average day is not appetizing, even for hungry investors. The market was undoubtedly craving something more reliable in the digital money space, and so far, stablecoins seems to be the satisfying answer.
We’ll see if the trend continues.