The Washington PostDemocracy Dies in Darkness

One of the hottest things in cryptocurrency right now: Stablecoins

(Thomas White/Reuters)
Placeholder while article actions load

There’s a new form of cryptocurrency gaining traction among fans of digital cash.

Unlike bitcoin, which has seen its price swing wildly from as high as $19,000 last year to its current level hovering around $6,200, this emerging class of cryptocurrency aims to maintain a stable price — one, single U.S. dollar — at all times.

A cryptocurrency whose price never fluctuates might sound nonsensical, particularly to entry-level traders who want to profit off a cryptocurrency’s appreciation. But many in the industry say the rise of “stablecoins” has in fact been instrumental for active investors — and could represent a crucial steppingstone to the future of money.

Bitcoin was hailed initially as a form of digital cash that could be used to purchase real-world goods and services. But in practice, the currency’s volatility has made buying anything with it far more complicated. In one early example from 2010, a programmer offered to pay for two pizzas with 10,000 bitcoin. At the time, that amounted to roughly $30. At today’s prices, it would be equivalent to $62 million.

“I don’t know whether the price of that crypto is going to go up or down, but it’s almost certainly not going to be the same as it is today,” said Josh Fraser, co-founder of the cryptocurrency start-up Origin Protocol. “That introduces the problem [for] either the buyer or seller . . . as part of that transaction.”

That’s why many in the industry now see stablecoins as a big opportunity that could fulfill much of bitcoin’s original promise as a medium of exchange.

In recent months, dozens of stablecoin projects have been launched or announced. With names like TrueUSD, Paxos, Havven and Dai, this new crop of coins enjoys a combined market cap of more than $2.3 billion, according to CoinMarketCap, which tracks the price of hundreds of cryptocurrencies.

In September, Gemini — the cryptocurrency exchange supported by the twin entrepreneurs Cameron and Tyler Winklevoss — announced the Gemini Dollar; earlier this month, the payments company Circle said its U.S. Dollar Coin would become available on Coinbase, one of America’s most prominent exchanges.

“Stablecoins bring some of the early potential of crypto into view,” said Balaji Srinivasan, Coinbase’s chief technology officer, “and they make possible payments that are very small, very fast, very large, very international, very transparent and very automated.”

Giving the U.S. dollar digital properties reflects the next stage of evolution for money, supporters say, because it takes the best attributes of a reserve currency — its reliability and universality — and combines them with the newfound technological capabilities of a cryptocurrency. It may not only enable faster payments that don’t involve banks or the clunky Automated Clearing House system, but could also allow for new kinds of financial apps and services that don’t depend on partnerships with banks to function. Entirely new economic relationships could arise in the form of digital economic contracts that enforce themselves. Although bitcoin offered the same promise, experts say, it has been held back by technical challenges, prompting entrepreneurs to look for new approaches.

Many of the better-known stablecoins operate on a simple idea: Buyers pay a dollar to receive a digital token. The dollar is then held in reserve. If a buyer later decides to cash out, she can redeem her tokens for dollars at a one-to-one ratio. Buyers can also swap dollar-backed tokens for other cryptocurrencies, such as bitcoin or ethereum, at various exchange rates. Certain other stablecoin projects seek to use algorithms to control the money supply by adding and deleting coins so that the trading price always stays at one dollar.

The idea for a cryptocurrency that is all but identical to the dollar is not new. In 2014, a company named Tether launched a coin with a unique proposition: For every Tether in circulation, there would be one U.S. dollar to back it up.

Tether fulfilled an important need in the investor community, experts say. At a time of volatility in the cryptocurrency markets, Tether’s stablecoin allowed investors to seek the relative safety of a dollar-like vehicle without actually cashing out of the cryptocurrency space entirely, which could lead to costly fees and delays. (The company did not respond to requests for an interview.)

Tether proved wildly popular: By late August, its own market cap had hit $2.8 billion.

But not all was well: In the past several weeks, Tether has been hit by a massive crisis of confidence. On some exchanges, Tether began trading at well below a dollar, which is not supposed to happen for a currency whose sole purpose is to maintain a solid peg. While the precise reasons for the slippage remain unclear, investors have engaged in a sell-off, and Bitfinex — a major exchange that shares the same management as Tether — took hundreds of millions of Tether coins out of circulation. In one month, Tether lost almost $1 billion in its market cap.

Part of what’s driving the chaos is a long-standing suspicion among some Tether skeptics that the company lacks the dollars on hand to repay people should they seek to redeem their Tether tokens en masse. A related concern is that if there are more Tether tokens in circulation than there really ought to be, and the Tether is being traded for other cryptocurrencies, then perhaps those currencies' prices could be overstated, resulting in possible distortions and uncertainty in the wider market. Tether has not succeeded in tamping down those fears; the company has steadfastly avoided opening its books for a professional audit, despite making claims that it is solvent.

Although Tether is still the most dominant stablecoin, the chaos appears to be helping its rivals, according to an analysis by the publication CoinDesk, which noted an uptick in the market shares of TrueUSD and U.S. Dollar Coin in recent weeks.

The secrecy and uncertainty surrounding Tether has encouraged many other entrepreneurs to build competing dollar-backed coins that have “more transparency” than Tether, Fraser said.

Critics of stablecoins say they can’t work, because they ignore what economists have learned over hundreds of years.

Preston Byrne, a cryptocurrency entrepreneur, has called stablecoins a “techno-magical idea,” particularly referring to the projects that rely on algorithms to control the money supply. Dictating the price of the currency and expecting the market to obey, rather than allowing the market to set a currency’s price, is backward, he has said.

For a company to amass billions of dollars on the off chance it will have to pay it out all at once makes for an expensive business model that doesn’t scale, wrote Barry Eichengreen, a professor of economics at the University of California at Berkeley, in a recent op-ed. Holding just a fraction of the needed reserves isn’t much of a solution either, he added, because it could lead to disaster in the event of a run on the currency.

“All of this will be familiar to anyone who has encountered even a single study on speculative attacks on pegged exchange rates, or to anyone who has had a coffee with an emerging-market central banker,” he wrote.

Yet some of the cryptocurrency industry’s biggest players insist that soon we will see not just digital tokens backed by U.S. dollars, but also others mimicking the euro, the yen, the British pound and many others.

“I don’t think in five years people will be calling them stablecoins,” said Jeremy Allaire, the chief executive of Circle. “It’ll just be ‘money on the Internet.’”