Why Stablecoins Are On The Rise

According to Bitstamp and CoinMetrics’ recent report, stablecoins have been a long time coming. Even before the creation of Bitcoin, people sought a controllable, viable digital currency. However, the rise of stablecoin is shocking when you consider its overall history. For five years, the stablecoin supply slowly crept up to 6 billion. And then, for some unknown reason, it only took only four months for it to grow from 6 billion to 12 billion.

While it’s likely that this resulted from the crypto crash on March 12th, 2020, and the compounding economic collapse that also followed the introduction of the COVID-19 pandemic in US markets, stablecoins have become more attractive to the public. They likely see its possible use in digital currency, crypto asset trading, and investing.

Mitigate Cryptocurrency Risk

The main reason why stablecoins were created was to mitigate the risk associated with cryptocurrencies and to create a usable, fiat digital currency.

Even in the investment market, or for global asset quotes, cryptocurrency is seen as inherently valuable but also risky, and everyday currencies can only operate based on accountability, reliability, and regulation, even if they do come with a bit of risk.

The use of cryptocurrency, while landmark, did not make sense for everyday transactions. Cryptocurrencies can fluctuate drastically within a few hours, and this model does not work for regular transactions or investments. Therefore, the evolution of stablecoin was necessary and created an avenue for crypto transactions.

The first successful stablecoin was Tether, which emerged in 2014 and has since paved the way for other stablecoins to provide stable asset backing, reliable liquidation programs, and a framework for regulating stablecoin risk.

Decentralized Banking

Initially a fringe economic theory, decentralized banking (or decentralized finance, DeFi) is a financial institution that does not rely on centralized financial intermediaries, like banks, brokerages, and exchanges. Instead, DeFi functions off smart contracts, which are legal contracts that are written and bound by Ethereum-blockchain technology.

We talk about smart contracts in other articles, and these revolutionary pieces of software are changing the way our society can bank and access money online. By decentralizing the financial process, fewer people can control funds, and more people can openly manage them.

Decentralized banking provides many pros and cons. The biggest con right now is that in the US, at least, decentralized digital currencies like stablecoins are too unregulated, and so far, they do not comply with anti-money laundering regulations nor regulations protecting financial acts of terrorism (and related laws under OFAC). These regulations, in addition to others like Customer Due Diligence (CDD) or Know Your Customer (KYC), are required for all financial transactions, and stamping on regulations to stablecoins might prove very difficult. After all, the basis of the stablecoin is simultaneous user anonymity and transaction verifiability on the public blockchain.

Open Banking

Because of decentralized banking combined with the stablecoins greater stability, this asset provides a viable way for open banking to emerge. Open banking reflects an overall economic system where the access and control of banking and financial accounts are done through third-party applications, meaning that, once again, there is a less centralized control aspect to financial transactions, and instead, more outsourcing of the money processes can occur.

Because of decentralized banking, more financial institutions can exist without a centralized, physical location. And to provide financial compliance, these institutions rely on third-party partners who provide security, financial compliance, and the ability to outsource and mitigate risk.

Open banking puts more money in more people’s hands. More individuals globally can access the internet than ever before. By increasing the available access level, more individuals can buy digital currencies, seek unique ways to get out of poverty, and seek ways to get around restrictive national fiat currencies.

Competitive Economic Markets

Naturally, stablecoins create more competitive economic markets. Instead of relying on centralized banking, more fintech companies can introduce their own stablecoin, facilitate that transaction with an ACH API, and send money internationally.

Increasingly, stablecoins are being used as a medium of exchange. Cross-border payments and global remittances make sense for stablecoins, given their ease of use for international transfer. And now that it is available, digital currencies (including stablecoins and Central Bank Digital Currencies or CBDCs) are being considered compared to other international fiat dollars, which may have been hyperinflated following the March 12th crash.

The Office of the Comptroller has also greenlit the use of stablecoins, alongside CBDCs, by banks, which means that stablecoins have a unique opportunity to be created and the market monitored by federal financial regulators. While this may take away from the stablecoins functionality as decentralized, it also increases public interest in stablecoin use and creates competitive economic markets.

Stablecoins are More Than Just FOMO

While the idea of a stable digital currency has long been of interest, the growth of the Tether (USDT) stablecoin, the first successful stablecoin that launched in 2014, showed that crypto backed by a stable price (in Tether’s case, the use of the USD 1 in reserve) proved that stablecoins are real, viable, and have great potential.

With the growth of stablecoin proven, more stable coins were introduced following Tether’s success. However, the Bitcoin crash of March 12th brought attention to the risks of stablecoins. For this small amount of time (a few days following March 12th, 2020), the stablecoin market was more unstable than ever before; stablecoin prices rose, alongside public interest, to balance out the Bitcoin value crash.

This crash spurred more than just stablecoin interest but broader reform on global equity markets. As Bitstamp and CoinMetrics document, there was a huge rush to get into cash, and we, therefore, experienced a global shortage of dollars.

Also interesting is that stablecoins, primarily Tether, are used in crypto asset trading: “Stablecoins are used as a quote currency in crypto-asset trading pairs far more than fiat currencies on most exchanges,” states Bitstamp and CoinMetric, which shows how a stablecoin can prove to be a stable form of a digital currency and applicable in more uses than straight investing.

While the future development of stablecoins and other digital currencies are still yet to be explored, it’s clear that recent changes in economic markets, particularly the economic fallout due to the COVID-19 pandemic, have highlighted that stablecoins are more steady than cryptocurrencies like Bitcoin and they can be reliable.

And now that banks are allowed to create and issue stablecoins, we might see, for the first time, private companies existing and competing in the distribution of stablecoins and global currency markets.