As it stands, Bitcoin is the flagship product of the blockchain industry, with a market capitalization of approximately $170 billion at the time of writing (66% market dominance). It’s a vastly secure network, having not been breached since inception 11 years ago. It also boasts a 99.98% uptime, gives us the opportunity to custody our assets, disintermediate services plagued by middlemen, and engage in dynamic peer-to-peer economies. Despite this, adoption of the world’s most popular cryptocurrency remains low.
The extreme volatility displayed by cryptocurrency markets has proven a huge barrier to adoption. Stable, predictable valuations support many operations within modern day commerce. Recurring payments such as salaries, utilities, rent etc. all rely on the stability of the asset used for fulfillment. Loans, credit, savings and by extension financial planning are heavily based on the ability to predict future value. Let’s take a look at Bob’s woes when dealing with a volatile asset for a retail purchase.
Bob is looking to buy a new television, with a price tag of $1000, and resolves to put away $100 a week for 10 weeks. After 10 weeks, Bob should have amassed $1000. However, the value of Bitcoin has fallen 40%. Adding insult to injury, this happened in the 10th week, so Bob had no indication that he would be unable to afford the television until the last minute. Bob had intended to host Superbowl Sunday, and now Bob and his guests are left upset and disappointed. They may look to make last minute plans, which will cost significantly more considering everything has been booked/reserved, a cost incurred on top of the $400 Bob lost when Bitcoin’s value fell.
Cryptocurrencies are a superior medium of exchange when compared to fiat. In a decentralized ecosystem, they are able to process transactions faster, cheaper, and more securely. They enable the tokenization of real world assets, allowing for the creation of robust sharing economies. However, they have failed to fulfill the other two characteristics of effective money — being a store of value and unit of account. This makes it difficult to price goods and services, obscures financial statements and by extension the ability to make sound financial decisions, etc. Neither businesses nor consumers want to expose themselves to unnecessary currency risk.
“It’s not functional as a currency. The peaks and troughs are like an investment asset and are equivalent to gold” — Jack Dorsey
Exploring Cryptocurrency Volatility
On May 22, 2010, Laszlo Hanyecz, a programmer and early Bitcoin adopter, conducted what is believed to be the first purchase of a product with Bitcoin, by exchanging 10 000 BTC for two large Papa John’s pizzas, valued at approximately $41 at the time. Since then, a Bitcoin Pizza Index has been created to track the value of those Bitcoins — at the time of writing worth $92,983,295 USD. The idea that an asset can experience such a meteoric appreciation in price suggests the first issue with volatile assets, the lack of incentive to spend.
Why consumers may not want to spend their crypto? Short answer — it may go up
Bitcoin has experienced aggressive price swings both up and down, the latter of which presents merchants and those that may accept Bitcoin as a form of payment with a problem. Following the 2017 bull run that took Bitcoin to just under $20 000 USD, Bitcoin and other digital assets fell into crypto winter, with the flagship cryptocurrency falling as low as $3200, with many other cryptocurrencies suffering significantly higher losses. Accepting crypto poses issues for merchants, namely: difficulty pricing products, and currency risk — the value of their revenue could fall, however, expenses would remain the same, putting the business under undue financial stress
Why would brands and merchants not want to accept crypto? Short answer — it may go down
Will Adoption Bring Stability?
Before we address stable assets, it has been suggested that part of the reason Bitcoin and other digital assets are so volatile is low market caps. Along this line of thinking, if cryptocurrencies were to achieve mass adoption, larger market capitalizations would provide some protection against the aggressive price swings seen today, making them more usable.
However, looking at gold, an asset class that has persisted through the ages as a store of value, with a global market capitalization of approximately $8 trillion, the market cap argument begins to crumble. Gold regularly experiences annual fluctuations of +10%, and lost over 27% of its value in 2013 alone. Additionally, its volatility has increased overtime, suggesting that there is no real positive correlation between market maturity and price stability.
Will Stability Bring Adoption?
Stablecoins, price stable digital assets, have been proposed as a solution, and have garnered significant interest over the last few years. The development of stablecoins has erupted, from 30 projects (9 live) in 2018, to over 160 projects (28 live) in 2019. Tether, the largest stablecoin by market cap, has experienced the most volume within cryptocurrency markets, exceeding that of Bitcoin’s consistently since early August 2019, despite having a market cap that is 40 times lower. Further to this, in a research study conducted by Messari, it was found that more value was moved in stablecoins on the Ethereum network than in the native asset, Ether (ETH), exhibiting a shift in trust towards cryptocurrencies pegged 1-to-1 to majory currencies.
Today’s stablecoin solutions seek to combine the benefits of blockchain technology with the stability associated with certain fiat currencies. Stablecoins are crypto-assets that maintain a stable value against a target price — the most common peg observed today is to the US dollar, which is generally accepted as the global reserve currency. There are a number of different stablecoin projects, but generally the peg is maintained in one of three ways.
Real-World Collateralized (Fiat/Commodity)
Coins in circulation are backed in a 1-to-1 ratio (optimally) by fiat currencies, basket of goods, or other form of commodity or asset (e.g, DigixDAO is collateralized with gold). Collateralized stablecoins are a form of asset tokenization, allowing the collateralized asset to experience the benefits of blockchain technology.
Coins in circulation are backed by crypto-assets, e.g MakerDAO’s stablecoin Dai is backed by Ether (multi-collateral Dai can now be backed by a number of different cryptocurrencies). Due to the speculative nature of crypto assets, crypto-collateralized protocols usually require overcollateralization, Maker currently requires a 1.5 collateral ratio.
Non Collateralized (Algorithmic)
Coins in circulation are not backed, instead a smart contract is used to implement algorithmic stabilization, effectively acting as a central bank to increase/decrease the supply of coins accordingly in order to maintain the peg.
High Levels of Institutional Interest Provides Further Validation
The concept of stablecoins has been successful in attracting the interest of institutions and central banks. Notably, JP Morgan has been exploring its own stablecoin solution, JPM Coin, which has the ability to speed up securities and bond transactions. Wisdomtree, a New-York based asset manager and leader in ETF’s, has expressed interest in a regulated stablecoin. The G-7 Working Group, in partnership with the IMF and Bank for International Settlements released a report in October 2019 investigating the impact of stablecoins. Additionally, Banco Bradesco, Bank of Buscan, and Rizal Commercial Banking Corporation are exploring issuing their own stablecoin on IBM’s blockchain.
On December 12, Christine Lagarde, President of the European Central Bank, was quoted on the ECB’s twitter.
DigitalBits & Branded Stablecoins
DigitalBits is a protocol layer blockchain designed to support consumer digital assets, specifically branded currencies. Commonly associated with loyalty points and rewards programs, branded currencies are a dynamic asset category, and gained increased traction with the advent of Facebook’s Libra Project and Walmart’s stablecoin patent. These ventures into the branded currency ecosystem were made especially interesting with the focus on stable assets, specifically branded stablecoins.
Branded stablecoins are price stable digital assets issued and supported by a specific or group of brands, enterprises, institutions etc. The next stage in the evolution of price stable assets, branded stablecoins can move beyond simply combining stability with blockchain technology, to enhancing the relationship that exists between brands and consumers. Leveraging existing applications and vibrant, active brand ecosystems, branded stablecoins can be holistically integrated into the consumer experience. Ultimately, consumers may not even perceive that they are using a cryptocurrency.
“We may see a situation where many peoples first crypto asset isn’t Bitcoin or Ethereum, but a stablecoin issued by their favourite brand. It’s backed by real value, built into applications they know and love, and it’s based in fiat so consumers already understand how to use it. This is the new era of blockchain technology, and we are creating solutions that people will use in their everyday lives.” — Michael Luckhoo, DigitalBits Vice President.
A Stable Future
Stability is one of the cornerstones of commerce, and is regularly referenced as quintessenssial to creating a new global, fiat-free, digital cash system. We have seen that even if adoption of digital assets increases, there is no guarantee that stability will result. Stablecoins fill this gap in innovation, introducing not only predictability to cryptocurrency markets, but also a level of familiarity for the everyday consumer.
The future may not be predictable… but the money we use should be.
*Note – This was originally posted on Digitalbits’ Medium.
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