stablecoins

Cryptocurrencies are notoriously volatile, with falls of 20% in a day not uncommon. It’s one of the reasons why some people are nervous about entering the market. 

Stablecoins, however, aim to bring stability to a hot market by acting as an anchor.

Stablecoins are designed to hold their value, even when the rest of the market is swinging wildly.

But they don’t always work…

The stablecoin debate was ignited recently by Tether (USDT). The world’s largest stablecoin, which is supposed to remain at $1, lost more than 15% of its value in a day, falling off its crucial $1 peg.

So what is a stablecoin? And how can we make them more secure and trustworthy?

Stablecoins Are “Pegged” to a Stable Asset

As we’ll see in this article, there are many different ways to keep a cryptocurrency stable, but it usually involves fixing the price to something else.

stablecoin pegged to the dollar
Credit: MakerDAO

Stablecoins fall into four different categories depending on how they are backed:

1.  Fiat-backed stablecoins – pegged to a fiat currency, like the dollar. This is the most common form of stablecoin.

2. Crypto-backed stablecoins – backed by another cryptocurrency, but “over-collateralized” to absorb the bigger swings in value.

3. Non-backed stablecoins – pegged to nothing, but regulated by an automated central bank system. This is much like how normal currencies work.

4. Asset-backed stablecoins – pegged to an asset like gold, oil, or diamonds.

Let’s look at each one in more detail. 

1. Fiat-Backed Stablecoins

Examples: Tether, Circle, True USD, Gemini Dollar, Paxos Standard

Coins backed by fiat currencies are certainly the most popular stable cryptocurrencies. The US Dollar is the most common fiat currency used as a collateral. 

In this method, every token is backed on a 1:1 basis against real USD deposited in a bank account. If a stablecoin holder wants to liquidate his position, the coins will be destroyed and the deposited USD will be paid out. 

what is tether logo

However, as recent developments of Tether have shown, it is often not as simple as it seems.

Read more: What is Tether? The Controversial Stablecoin

To build trust in the coin, we need to know it really is backed by dollars on a 1:1 basis. 

Tether claims its reserves are 100% backed by real dollars. But a major issue is the auditing aspect – an independent review to confirm the claims. If the issuer does not provide public audits on a regular basis, people quickly assume the tokens are created out of thin air.

That’s exactly what happened to Tether when it crashed well below its $1 peg.

But Fiat is Flawed…

Then there’s the debate around fiat currencies in general. Since the abolishment of the gold standard in 1971, fiat currencies are constantly losing value through inflation. 

As a consequence of the economic crisis in 2008, Satoshi Nakamoto invented bitcoin as a hedge against the current monetary system. With that in mind, it appears quite ironic that bitcoin supporters are now using fiat-backed cryptocurrencies.

Tether Alternatives

Gemini dollar

If you still want to use a fiat-backed stablecoin, you might want to take a look at the alternatives of the notorious Tether. Three emerging stars in the stablecoin sectors are the True USD, the Gemini Dollar, and the Paxos Standard Token. 

The companies behind those tokens claim that they are fully regulated under US law and aim to provide audits on a monthly basis. 

Coinbase has also added support for a stablecoin issued by Circle, USDC. In addition, we might see a coin that is backed by Swiss Francs in the near future.

2. Crypto-Backed Stablecoins

Examples: DAI

A promising alternative to fiat-backed coins is tokens that are collateralized with volatile cryptocurrencies. 

In order to maintain price stability, the tokens need to be over-collateralized by 50 to 100%. 

Assuming you want to buy $1,000 worth of stablecoins, you will need to deposit crypto assets worth at least $1,500. This over-collateralization will be used to absorb the volatility of the underlying asset. If the price of the assets drop by 25%, the stablecoin will still be able to maintain its value.

DAI stablecoin

Threat of a Falling Market

However, in the world of cryptocurrencies, where assets previously dropped by 90% and more, it could make sense to deposit 100% or even more of the initial value. If your collateral is in danger, due to plummeting prices, you immediately need to increase your position. Otherwise, it will be liquidated. 

Experts frequently warned of a so-called “black swan event”, wherein a crypto-backed stablecoin would lose its value in case of a heavy market crash.

Using Crypto-Backed Stablecoins to Speculate

The main incentive for locking assets that actually carry a greater value is the fact that you can use the stablecoins as leverage (i.e. bet on an asset with more money than you actually have). 

If you think the price of a particular altcoin will rise in the future, you can easily use you stablecoins to buy even more altcoins.

A well-known project is called MakerDAO with its stablecoin DAI. In order to mint new DAI tokens, which are pegged to the US Dollar, investors need to deposit a premium amount of ether. 

The platform uses smart contracts in order to keep the price stable. In the future, MakerDAO plans on allowing other cryptocurrencies as well as tokenized real-world assets, like gold or stocks.

3. Non-Backed Stablecoins

Examples: bitUSD, Basis

basis stablecoin

After two methods backed by collateralized assets, it’s time to take a look at a radically different approach: a stablecoin that isn’t backed by anything at all. 

While it might sound like a bizarre idea at first, it’s exactly how the dollar works.

Since 1971 when the dollar moved away from the gold standard, it is solely backed by the belief that one unit will have the same buying power on the next day. So why shouldn’t this work in the cryptocurrency world as well?

Examples include bitUSD, which was founded by EOS, BitShares and Steemit inventor, Daniel Larimer. BitUSD was one of the first non-collateralized stablecoins on the market. 

Since late 2014, the price managed to stay more or less around the one dollar range. Its market capitalization is not as high as with other stablecoins, at only around $10 million. 

A very promising candidate for becoming a way bigger non-backed stablecoin is a cryptocurrency called Basis. The company raised $133 million in a private placement through various venture capitalists in 2018.  

An Automated Central Bank?

Basis works by expanding on an idea by macroeconomist Robert Sams. It means the blockchain acts like an automated, or algorithmic, central bank.

It’s actually a very simple idea. If the price of one coin rises above one dollar, the blockchain will issue and sell new coins to the market until the price falls down to one dollar again (it uses a smart contract to do so). 

During this stage, the smart contract generates profit by selling new coins. These will be kept as a reserve.

If the price falls below the value of one dollar, the smart contract will use the reserves to buy back coins from the market.

4. Asset-Backed Stablecoins

Examples: DigixDao’s Gold Token, Diamcoin, Petro

Cryptocurrencies backed by real-world assets are the latest members of the stablecoin family. But this type of stablecoin tries a completely different approach than its relatives. 

In these cases, the price of the stablecoin is defined by its underlying asset whether it’s diamonds, oil, gold, or something else entirely.

Perhaps the most high-profile case is petro – a cryptocurrency created by the Venezuelan government. Its value is backed by the price of an oil barrel. The petro, however, has been wrapped up in controversy since its launch. 

Read more: Everything You Need to Know About Venezuela’s National Cryptocurrency

The UK Royal Mint was also planning a digital gold token, but it has since suspended the project. 

We’ve also seen the launch of gold-backed coins. The DigixDao’s Gold Token is the best known. Although the value of gold generally increases in the long term, its price still fluctuates quite a lot on a typical day. This means it might not be the best candidate for a stable currency in the short run, but rather as a safe investment for the future. 

Stablecoins “Necessary to Replace Payment Systems”?

Sir Christopher Pissarides, Economic Nobel Prize winner of 2010, concludes that asset-backed stablecoins might have a great impact on the adoption of digital currencies. 

According to Pissarides, who is involved in a diamond-backed cryptocurrency called DiamCoin:

“Blockchain technology has the potential to disrupt the current financial system, but it is still mainly used for speculation. If we can eliminate the volatility and bring in stability, we now have the financial tool necessary to replace the archaic payment systems in place today.”

 

Whether a stablecoin is backed by real-world assets, fiat, crypto, or nothing, we probably need to wait a few more years until we can really see which stablecoin class proves to be the least volatile cryptocurrency.

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nouriel roubini

Welcome to the weekend, folks. Grab a coffee and let’s recap the biggest news stories of the week in cryptocurrency and blockchain.

“The Mother and Father of All Bubbles”

“Dr. Doom” Nouriel Roubini is a New York economist who famously predicted the 2008 financial crisis.

Now he’s turning his attention to cryptocurrency, calling it the “mother and father of all scams and bubbles” in a statement made to US Congress.

His meandering statement also takes on blockchain, referring to it as a “glorified spreadsheet.”

Nouriel Roubini’s soundbites are damning and headline-grabbing. But they often ring hollow when we investigate it further. Here are some of the things he got wrong:

1. “Paying $55 dollars of transaction costs to buy a $2 coffee cup is obviously never going to lead Bitcoin to become a transaction currency.”

Roubini is referring to December 22nd, 2017 when the bitcoin transaction cost briefly hit $55. However, this was the peak of bitcoin mania. To use this as a broad statement on transaction fees is misleading.

In the last three months, the bitcoin transaction price has barely peaked above a dollar. And we recently saw one investor move 29,999 bitcoins (worth $194 million) with a transaction fee of just $0.1.

bitcoin transaction fees

Congestion and scalability is, undoubtedly, bitcoin’s largest challenge, but Roubini is sensationalizing the facts based on one day in bitcoin’s ten-year history.

2. Blockchain is “no better than a spreadsheet or database”

Actually, it’s significantly, objectively better.

A spreadsheet or database is almost always controlled by one person or entity. It can be manipulated and falsified. It can be easily hacked or stolen because there is usually one point of failure.

A blockchain is a spreadsheet that lives on thousands of computers all at once. It’s updated in real-time. It’s not owned or controlled by any one person, which means it can’t be hacked or manipulated (because the entire community would see it happen and refuse to accept it).

I say it’s objectively better because the bitcoin blockchain has never been hacked. (Only things built to interact with it, like exchanges, have been compromised).

3. Bitcoin has “now gone bust”

Actually, bitcoin has suffered much larger percentage drops in price and survived.

The first bitcoin crash in 2011 wiped out 93% of value. The second took 70% off the price. The third took 83%.

bitcoin-selloff-crashes

2018’s 65% decline might have involved a much higher market capitalization, but big percentage falls in bitcoin is nothing we haven’t seen before. 

Bitcoin recovered from every previous crash without “going bust.” To say bitcoin has gone bust this time around is to underestimate the strength of the community, not to mention all the institutional support slowly building around it.

4. Bitcoin’s “only real use has been to facilitate illegal activities such as drug transactions, tax evasion, avoidance of capital controls, or money laundering”

What about the people in Venezuela using bitcoin to free themselves from 1,000,000% inflation in fiat currency?

How about the Cypriots that used bitcoin when the government confiscated the money in their bank accounts?

Of course, bitcoin has been used for drugs and money laundering. But bitcoin has also empowered people, which is perhaps its most important use-case so far.

Bitcoin’s Spike, Tether’s Decline

Bitcoin recorded a rapid 10% spike on Monday. At the same time, the world’s largest stablecoin, Tether, fell from its $1 peg to as low as $0.85.

Tether is under renewed criticism that its tokens are not fully backed by real dollar reserves. The skepticism intensified on Monday after crypto exchange Bitfinex was rumored to be on thin ice financially.

Both Tether and Bitfinex are run by the same CEO, so concerns about Bitfinex lead to worries over Tether’s solvency.

Read more: What is Tether? The Controversial Stablecoin?

0x Listed on Coinbase, Price Soars 70%

0x (ZRX) became the first ERC-20 token to be listed on Coinbase this week. 0x is a promising decentralized exchange platform that powers the exchange of tokens, loans, gaming items, and just about anything else.

0x coinbase

ZRX is available to those using Coinbase’s premium service, Coinbase Pro.

The price of ZRX soared 70% on the news but fell back 15% later in the week. The project’s founder and CEO urged caution on the price, saying: “This is probably a good time to remind everyone that 0x is a highly experimental technology that is built on top of another piece of highly experimental technology.”

0x founder tweet

Weekend Reading

Ethereum eBook – We released our second deep-dive eBook this week: Absolutely Everything You Need To Know About Ethereum. It’s completely free to download (no email address required).

8 Cryptocurrency Best Practices – From safe storage to backups, this guide teaches you how to keep your crypto safe.

Do You Need Cryptocurrency Insurance? – If you own crypto, it’s probably not insured. Crypto exchange Gemini is trying to change that, but what else can you do to stay safe?

That’s all for this weekend. We’ll see you back here bright and early on Monday morning.

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what is tether logo
  • Tether is a “stable coin” designed to mirror the price of one dollar
  • 20% of all cryptocurrency trades use tether as a proxy for the dollar.
  • Tether claims its coins are 100% backed by real US dollar reserves, but this has never been independently proven.
  • Tether is linked to controversy over close links to the Bitfinex exchange and market manipulation.

Tether is wreaking havoc on the markets this week as traders move money out of the stable coin and into other cryptocurrencies.

Tether (USDT) is known as a “stablecoin” as its value is pegged to the price of a dollar.

When it was first introduced, it brought a degree of stability to the volatile cryptocurrency market. It allowed investors to easily trade bitcoin against the dollar and was even used by Taiwanese banks to execute international transfers.

But this week tether slipped off its “peg,” falling as low as $0.85 on the Kraken exchange.

tether price chart

It was triggered by claims that tether is not fully backed by real dollars. To add fuel to the fire, tether is closely linked to Bitfinex – a cryptocurrency exchange rumored to be on thin ice financially.

All this combined on Monday, resulting in a mass exodus from tether. 

But what is tether, exactly? How does it work? Why do cryptocurrency traders use it, and why is it so controversial?

What is Tether?

Tether first emerged in 2015. It’s a coin designed to bring stability to a volatile cryptocurrency market.

The price of tether is pegged to the US dollar so, theoretically, one tether token should always be the same as a dollar.

In reality, the price of tether fluctuates against the dollar slightly. Generally speaking, however, it’s as stable as cryptocurrency gets.

There are currently 2.3 billion tether tokens in circulation.

According to Tether, each token is 100% backed by a real US dollar in a reserve bank.

“Every tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD.”

what is tether website screenshot

This claim, however, is a huge source of controversy (we’ll get into that shortly).

How is Tether Used?

According to Bloomberg, tether is used in 20% of all cryptocurrency trades. And as you can see in the chart below, tether is the second-most traded cryptocurrency by volume, according to CoinMarketCap.

tether trade volume coinmarketcap

There are many good reasons for this:

1. Easily trade against the dollar

Because tether mirrors the price of a dollar, we can use it to trade against bitcoin and ethereum as it moves against the dollar without actually using fiat currency itself. It’s faster and more efficient.

2. Keep money on the sidelines

Traders often keep their money in tether while waiting for the perfect moment to enter a position or investment.

In the ongoing bear market, for example, traders can keep their money stable in tether while the rest of the cryptocurrency market declines.

Why don’t they just withdraw their money to real dollars? Well, some cryptocurrency exchanges don’t even support dollars. And by the time traders have moved their dollars onto an exchange, they may have missed an opportunity.

By keeping money in tether, they can execute a trade quickly.

3. Exchanges don’t always support dollars

Many cryptocurrency exchanges don’t support dollars. On Binance, the world’s largest crypto-crypto exchange, for example, you can’t deposit, withdraw, or trade fiat dollars.

Supporting fiat currency means complying to complex regulation and setting up bank partnerships. Some exchanges don’t have the means or inclination to do this.

Instead, they rely on tether to provide dollar liquidity. Tether is simply used as a proxy for the real dollar.

Who Created Tether?

Tether’s CEO is Jan Ludovicus van der Velde. He’s also the CEO of Bitfinex, a controversial Hong Kong cryptocurrency exchange.

Both tether and Bitfinex also share a chief strategy officer, Phillip Potter.

This close relationship with Bitfinex has fueled rampant speculation about tether and its legitimacy.

bitfinex logo

Is Tether Really Backed by $2 Billion Dollar Reserves?

The speculation ultimately comes down to this question: is every tether token backed by a real dollar?

Tether certainly claims so. Its website says every tether is 100% backed.

Tether’s white paper also promised that:

“Professional auditors will regularly verify, sign, and publish our underlying bank balance and financial transfer statement.”

However, no independent audit has ever been able to prove the underlying funds.

A report by researchers at Texas University concluded that tether backing is “incomplete.” In other words, there aren’t enough real dollars to back every tether.

Tether has always disputed this claim. They even hired a law firm to provide documentation. Freeh, Sporkin & Sullivan LLP (FSS) produced a report that concluded that Tether’s two banks held $2,545,067,236 USD. That’s enough to cover the tether tokens.

It’s worth pointing out, however, that FSS later confirmed this was not an official audit.

Why Does it Matter?

If tether doesn’t have a fully backed dollar reserve, there’s a risk of cryptocurrency “bank run.”

To explain, let’s start with your normal bank account for a moment.

Let’s say you’ve got $1,000 in your account. Your bank doesn’t actually have that $1,000 cash sitting in a vault.

The bank only keeps a small amount in reserve for people to withdraw (the rest is loaned out or invested in other assets).

This is called “fractional reserve” banking. Banks only need a “fraction” of the total reserves on hand.

Usually, that’s not a problem because most people have savings accounts they don’t touch very often. No-one needs all their money at one moment.

But let’s say there’s an economic crisis. Everyone might flood to the banks to get their money out. If there’s not enough money in the bank for everyone to withdraw, it’s called a “bank run.”

The same thing could happen to tether.

If everyone holding tether simultaneously decides to sell their tokens, tether needs to be able to give them back their dollar equivalent.

And if tether doesn’t have those dollars available in reserve, it could crash the system.

Controversy Around Tether and Bitfinex

This week’s controversy around tether isn’t new.

Tether has been accused of market manipulation in the past. One research paper earlier this year claimed that tether manipulation was responsible for bitcoin’s phenomenal all-time-highs in December 2017.

How?

In simple terms, the researchers claim that Bitfinex (which we know is closely linked to tether) was creating tether tokens out of thin air when traders bought USDT.

These “magic” tethers were then used to purchase bitcoin – artificially inflating the price.

Of course, if this is true, those tether tokens were not backed by real dollar reserves.

Conclusion

Tether is a fantastically useful cryptocurrency. It brings an element of stability to the cryptocurrency market and provides an easy way to trade against the dollar.

However, tether and the team behind it are unable to shake the claims of controversy. Until tether releases a full independent audit, critics will continue to question their dollar backing.

Similar stable coins like the Gemini dollar and Paxos Standard gain momentum every time tether stumbles. For now, however, tether remains the largest stable coin by far, and the eighth largest cryptocurrency by market cap.

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bitcoin price rise

The price of bitcoin spiked more than 10% on Monday morning. Ethereum, XRP and bitcoin cash also exploded to double-digit gains before settling later in the day.

Bitcoin Price Teases $7,000

According to CoinMarketCap, bitcoin’s price spike hit $6,965 before dropping back to $6,660. However, Bitfinex – a cryptocurrency exchange in Hong Kong – charted bitcoin at $7,788 at its highest point.

So, what accounted for this rapid price rise?

Huge Sell-off in Tether

Bitcoin’s surge was triggered by traders selling tether – a “stablecoin” which is pegged to the US dollar.

Tether is typically used to trade cryptocurrencies against the dollar without having to use fiat currency itself. Tether is also used to keep money “on the sidelines” before entering a particular trade. Since it’s pegged to the US dollar, it is a relatively stable asset.

A reported 20% of all crypto trades are made using tether.

What Caused the Tether Sell-off?

According to Bloomberg, the implosion appears to have been caused by renewed rumors of insolvency at crypto exchange Bitfinex. Bitfinex has been plagued by speculation over its financial health and banking relationships.

That’s a problem for tether because Bitfinex and tether share a CEO.

The nerves about Bitfinex’s financial health appear to have spilled over into concerns over tether.

In an attempt to downplay concerns, Bitfinex was quick to point out that “all cryptocurrency and fiat withdrawals are, and have been, processing as usual without the slightest interference.”

FALSE RUMOR: Binance is Delisting Tether

One rumor circulating Twitter on Monday morning hinted that Binance – the world’s largest crypto-to-crypto exchange – was set to delist tether. It was fueled by an image that reportedly showed an email from Binance announcing the forthcoming delisting.

Binance CEO, however, confirmed it was a faked Photoshop image. While this may have initially caused a panic sell-off in tether, it should have no further impact on the price.

For now, the price of bitcoin has dropped from its spike to a stable $6,640.

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