Why do we need stablecoins?

Source: Wang Jian’s Perspective

01 What is a stablecoin?

A stablecoin is a monetary system design that is different from legal tender, digital currency, and encrypted currency. Here we use a rather awkward word called "monetary system design" because we are not sure whether it is a real currency.

A typical stablecoin mechanism is (refer to the plan in Hong Kong, China. Plans in other places may vary):

The issuer (private sector) reserves a certain amount of real assets (domestic or foreign legal tender, or other creditworthy financial assets, such as government bonds, precious metals, and may also include encrypted currencies), and issues a certain number of stablecoins with 100% of one or a group of real assets as reserves, and then this stablecoin is traded on a distributed ledger.

Note a few points:

(1) The issuer is the private sector, not the official monetary authority (such as the central bank). 

(2) There is a 100% real asset reserve, which can be a combination of one or more. 

(3) It runs on a distributed ledger. Centralized deposit currencies are not included.

This solution ensures that stablecoins will not be over-issued, because each dollar of stablecoin has a reserve of real assets, and the holders of stablecoins can also redeem the reserve assets from the issuer at any time. If the reserve assets are legal tender, then the credit of the stablecoin can be basically consistent with that of the legal tender.

And if the reserve assets are set as a combination of multiple assets, it can also offset the currency fluctuations caused by large fluctuations in a certain asset.

Then stablecoins run on distributed ledgers and can enjoy various benefits of decentralized systems, such as limited anonymity (market entities cannot peek at other people's transactions, but judicial or regulatory authorities can under necessary procedures), difficult to tamper with, and cannot kick people out (such as the kicking operation of a payment organization). Moreover, the peer-to-peer transactions of distributed ledgers naturally break through national borders, so it is naturally an international payment and settlement mechanism.

02 Characteristics of stablecoins

The earliest stablecoin was USDT, which was launched by Tether in July 2014 and officially traded on the exchange in February 2015. The reserve behind it is the US dollar, which is currently the largest stablecoin in the world.

The original intention of launching USDT was that cryptocurrencies represented by Bitcoin were popular in the market at that time, but their currency values ​​fluctuated greatly, and it was obviously impossible to perform the functions of currency. Therefore, a currency corresponding to the US dollar at a 1:1 ratio was designed, and it runs on a decentralized distributed ledger like cryptocurrencies.

It can be seen that the original intention of stablecoins was to connect traditional finance with crypto finance.

From the perspective of the 1:1 setting of the US dollar, it is more like a token of the US dollar, but this token is connected to a decentralized distributed ledger, which makes it easier for everyone to use. Later, USDT's reserve assets became diversified, adding other content such as cryptocurrencies, gold, and corporate bonds. In addition to deposits, the US dollar reserves held also include US bonds.

The diversification of reserve assets can also alleviate people's concerns about the fluctuation of the value of legal currency. After all, in those years, in addition to the sharp fluctuations in the value of cryptocurrencies, some countries implemented policies such as QE to over-issue currencies, which led to concerns about the value of legal tender.

USDT is welcomed by all parties, especially as a natural cross-border tool, residents of other countries will also begin to use it. Especially for some areas where formal finance is underdeveloped, people can use stablecoins with just a smartphone, without a bank account. Therefore, stablecoins will also be used in the gray economy and cross-border payments, challenging supervision and even offending the monetary sovereignty of a country or region.

At this time, more and more formal financial institutions and companies have also begun to accept stablecoins, such as payments in trade. Then some international investors also regard stablecoins as a tool for investment or savings because it just corresponds to a basket of good assets.

If a new thing does have its value and challenges supervision, then the best way to deal with it is to bring it under standardized supervision. In recent years, many countries and regions have begun to formulate regulatory measures to standardize the operation of stablecoins.

03 The future of stablecoins

Now many countries and regions have begun to regulate stablecoins in a standardized manner and have launched their own stablecoin solutions. Due to the natural cross-border nature of stablecoins, various stablecoins will compete on the international stage in the future to compete for user use.

First, stablecoins are used for cross-border payment and settlement, which poses a challenge to the original centralized payment and settlement methods. The most classic method of cross-border payment and settlement is centralized, similar to "SWIFT+ clearing agencies", but there are problems such as high cost, low efficiency and susceptibility to political interference. The multilateral currency digital bridge (using central bank digital currency) is a decentralized solution that has recently emerged and is currently in a rapid development process. Stablecoins are a brand-new idea that seems to have strong advantages in many details, but it poses a relatively large challenge to supervision, and there are still many regulatory issues that need to be resolved.