Stablecoins

The principal concern about cryptocurrencies is volatility, which causes jumps in the price of the assets, making sudden changes.

Nevertheless, blockchain technology has made, and is still making, enormous progress towards the creation of a crypto asset that can be used as a means of exchange to purchase goods "pegged" to an official currency. And so it is that the solution could be the Stablecoin, token whose exchange is recorded in a blockchain exactly as for bitcoins, but differs from the latter on a relevant aspect: its value is anchored to a real asset or good, making it a relatively more stable currency. More specifically, there are three methods to peg the value of a token (an asset that only exists in the blockchain) to another asset or physical good.

The first anchors the Stablecoin to a physical collateral: assuming that a token is worth one dollar (as it is for Tether), the person who creates said asset pays into a reserve, such as a bank account, one dollar or the equivalent in low-risk financial securities. Thus, the amount, which is equal to the tokens generated, acts as collateral to secure its value.

A second method involves digital collateral: in this case, crypto assets of higher value than the token are frozen for each token created to prevent high volatility. Here, it is crucial that the value of the frozen assets remain higher than the value of the created tokens, but in case the two-approach parity, there are possible rebalancing mechanisms that allow the collateral to continue to act as collateral.

The last option concerns the algorithms, which maintain parity (even if they don't always succeed), in an automatic way: they create tokens if the respective value in official currency increases, or on the contrary, they destroy them if it decreases.

Clearly, the method that makes the Stablecoin less volatile is the one that hooks it to a physical collateral, and in fact Tether, which is pegged to the value of the dollar, is the Stablecoin most used. This Stablecoin can be an excellent example to understand its exact functioning: the purchase and sale of Tether takes place on the exchange channel market where the buying and selling is between individuals, or through Tether Limit, the company that creates the tokens. In the latter case, the tokens are generated by the company upon payment of a quantity of dollars, or, if not, it delivers to the user dollars equivalent to the destroyed tokens. This ensures parity between Tether and dollars by making sure that there are as many tokens in circulation as there are dollars in the reserves.

The thing that makes Tether a stable digital currency compared to other tokens like Bitcoin is the community that relies on it. A Bitcoin today is worth between 30 and 40 thousand, this is because there are people who appreciate and believe in the value of this currency. But when Tether Limited declared in 2019 that reserves only covered 74% of the tokens in circulation, the value of Tether in exchanges remained almost unchanged. This is as much because of the validity of the collateral to which it is pegged as it is because of a customer base that has continued to purchase Tether in secondary markets at $1 per token.

Despite this, to date Tether, or Stablecoin in general, are rarely accepted for the purchase of goods. The problems are various, from the security of digital wallets to the slowness of the blockchain now of the transaction. A critical aspect concerns the stability of these cryptocurrencies: that of Tether was just a lucky event. It is not enough to have a community that believes in them to avoid volatility, but it is necessary that the financial reserves are reliable and stable. This worries governments and central banks. Facebook, which created its currency Libra in 2019, is the quintessential example. The U.S. Senate, pondering that the Libra Association could become the competitor par excellence in the banking world, did not allow the project to be taken further. One can well understand that the fear of the banking system is well founded: there are 5 top Stablecoins with a capitalization of more than 5 billion (Tether, USDC, Binance USD, Dai and TerraUSD). Roughly, the amount of their value, if measured purely in volume of assets, is equivalent to one of the top 30 American banks, with a value of about 140 billion dollars. The Biden government is concerned about the exponential growth and is pushing for more measures, as rapid expansion always involves non-negligible risks.

One of the main concerns is the transparency and quality of collateral. Considering the high capitalization that these companies have, if doubt were to spread about the securities backing these currencies, it would trigger a "panic selling" effect, incurring a crisis that we know well in the financial and non-financial market. Tether in 2021 has already had to pay two penalties for misrepresentations about the amount of assets backing the tokens in circulation. USD Coins would also seem to be under scrutiny as Coinbase, the transaction channel used, has over the years made conflicting statements about the nature of their reserves.