Stablecoins are having the best year of their lives in 2020 as the combined market capitalisation of all stablecoins grew by nearly 400 percent year-on-year, according to data from Luno.
Some of the world’s biggest stablecoins have made massive gains in recent times. Tether alone accounts for almost 80 percent of the total stablecoin market, and its circulating supply is expected to surpass $20 billion. USDC is the second-largest stablecoin with more than $3 billion worth of USDC in circulation.
A report by Coindesk showed that the supply of stablecoins has surged since September 2019 by more than 1,200 percent. As of May, the total stablecoin supply surpassed $10 billion for the first time closing the second quarter of 2020 a little below $12 billion. Aggregate supply closed Q3 at $19.87 billion, nearly breaking above $20 billion on the last day of September 2020.
What is stablecoin?
A stablecoin refers to a new class of cryptocurrencies that offer price stability and are backed by a reserve asset such as the US dollar or Euro.
The idea of stablecoins was born by the high volatility in the valuation of cryptocurrencies like bitcoin. For example, in 2017, the world’s largest cryptocurrency by valuation rose from a level of about $5,950 in the early weeks of November 2017 to above $19,700 in December of the same year, only to come crashing down to $6,900 by early February 2018. Even the intraday price of bitcoin can swing uncontrollably: it is common to see the cryptocurrency moving in excess of 10 percent in either direction within a span of a few hours.
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This short-term volatility arguably makes cryptocurrencies like bitcoin unusable in day-to-day transactions. Usually, a currency should act as a medium of monetary exchange and a mode of storage of monetary value, and its value should remain relatively stable over long periods. This is mostly why fiat currencies are backed by reserves, like the Nigerian foreign reserve which is managed by the Central Bank of Nigeria (CBN). Fiat currencies are also backed by assets such as gold which keeps them away from wild swings.
Another factor that keeps fiat currencies from wild swings is the presence of controlling authorities like the CBN and their ability to step in and manage the demand and supply of currency to maintain price stability. Cryptocurrencies generally lack these properties, hence their high volatility rate. This is also why stablecoins as a balance between cryptocurrencies and fiat currencies.
Categories of stablecoins
There are three to four categories of stablecoins namely fiat-backed or fiat-collaterised stablecoins, commodity-backed stablecoins, cryptocurrency-collaterised stablecoin, and non-collaterised stablecoins.
Fiat-backed stablecoins are backed by fiat currencies like the US dollar, euro. They are akin to the digital versions of the fiat currencies. The much-anticipated Central Bank Digital Currencies (CBDC) will be backed by originating countries’ fiat currencies. Facebook’s Libra which is likely to launch in January 2021 will be backed one-on-one by the US dollar.
Commodity-collaterised stablecoins are backed by the value of things such as valuable metals, gas, and gold.
Crypto-collaterised stablecoins are supported by other cryptocurrencies. For this category, the value is usually over-collaterised given that the reserve cryptocurrency may also be prone to high volatility.
Non-collaterised stablecoins are not backed by any asset. They are governed by complex algorithms, hence if the demand of the cryptocurrency assets increases, a new supply of stablecoins is instantly created (and vice versa).
Regulatory push for stablecoins
The growth of stablecoins has placed stablecoins on the radar in the US congress, leading three members of the congress to propose the Stablecoin Tethering and Bank Licensing Enforcement (STABLE) Act.
The STABLE Act would require Tether and other stablecoin providers to have a banking charter and to be approved by the Federal Reserve and FDIC in order to issue stablecoins.
The motivation behind the act is to protect lower and moderate-income consumers. Several crypto influencers have spoken against the STABLE act, highlighting that cryptocurrencies lower the cost of servicing populations that have historically been excluded from the banking sector.
