What was supposed to be the year of the bitcoin became the year of the stablecoin. The last quarter of 2018 alone saw the release of nine new stablecoins. The high volatility of cryptocurrencies made stablecoins as Tether (USDT) a Godsend safe haven. In 2019 a lot of new stablecoins will become available for the public. They are appealing for one simple reason: they offer stability in a word known for being volatile. But how stable are these stablecoins really?

 

Inflation

After the oil crisis of 1973 the United States depegged their US Dollar from the Bretton Woods system – the gold backed currency system. As the chart above shows; the purchasing power rapidly dropped afterwards. This is because of inflation. Inflation basically means that a consumer has to hand over more dollars to buy the same item. To illustrate this, here is an example with some calculations:

 

From 1860 until 1970, there was an average inflation rate of about 1.41% per year. That means that if I were to buy a deck of cards in 1860, it would cost me $1. If I didn’t buy it then, but waited until 1970 to buy that same deck of cards, it would cost me $4.67. Compare that to the following: a milk bottle in 1970 would cost $1. If I were to buy that milk bottle today, I will have to pay $6.49 at the cashier.

 

To put it in simple terms: with a gold backed system, it took the US Dollar 110 years, with an average inflation of 1.41%, to drop to the level of 1970. With a depegged system the same happened in just over 30 years – the inflation rate was a whopping 4.91% per year. To illustrate the effect again: if I put a $1 bill in my piggy bank today, I could only buy something worth $0.95 next year, compared to today’s prices.

 

Gold

Does that mean a gold pegged currency is the solution we’ve all been waiting for? Gold is seen as a safe haven in times of crisis. Around every crisis – the 1973 oil crisis or the dot-com bubble – the gold price spikes.

 

During crises, the gold price becomes highly volatile. Similar movements can be seen with silver and platinum. A cryptocurrency soly backed by gold will see similar problems as one purely backed by the US Dollar: the stability is relative. This means that in economic turmoil, the stablecoin backed by gold will become very unstable: exactly the opposite of what it tries to achieve.

 

In the end, the stablecoin is only as stable as the underlying asset. In times of economic downturn, the underlying asset, such as gold can change in price considerably. So, how can these issues be solved?

 

Hedging

The most common way to reduce the risk of big price changes of the stablecoin is to have it backed by multiple assets. This is called hedging and it can be backed by a fiat or cryptocurrency basket, a basket of multiple precious metal or a combination of the previous ones.

 

This has various advantages to only having one asset backing the cryptocurrency: price changes in one asset will be set off against price changes of the other assets. What this basically means is that the volatility of a price drop in one asset will be reduced by the other assets. Thus, creating stability.

 

Having a wide variety of assets backing a stablecoin, such as gold, different fiat currencies and maybe even real estate, will make the stablecoin truly stable. This in opposition to the stablecoins only backed by one asset: the worth of the asset can change the worth of the stablecoin drastically in times of economic turmoil.

 

In conclusion, the stablecoin is only as stable as its underlying asset. In the case of both the US Dollar – a favourite pick – and gold, this does not provide a lasting solution to the volatility of cryptocurrencies. Hedging can create automatic stabilizers, as stablecoin backed by only one asset will have a hard time surviving times of crisis.


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Who you’re reading:

Augustus van Gassen is a staff writer at The Decentral, living and writing in Tokyo, Japan. He likes to debate the finer parts of cryptocurrency and politics to anyone who will listen.

Disclaimer: Any and all opinions expressed here are those of Augustus van Gassen alone. The article is for educational and/or entertainment purposes only, so please use it at your own risk.