3 Clever Ways To Reach Crypto Price Stability, And One Giant Leap Of Faith

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Forbes | | Sep 17, 2018

People keep asking me, what’s the deal with stablecoins? With two prominent regulatory approvals to issue the blockchain-based tokens, many have heralded them as the next evolution of cryptocurrency, while others say they’re perfect evidence of why no one ever needed cryptocurrency in the first place.

On a basic level, a stablecoin is a token that has a mechanism in place to minimize its price fluctuations. Unlike traditional cryptocurrencies such as bitcoin and ether, which are directly tied to their wildly fluctuating demand, a stablecoin can rely on four methods to constrain its fluctuations.

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The first and by far most popular way to achieve this stability is to peg the price of the token to a more stable asset like the U.S. dollar. This is what both the Gemini and Paxos cryptocurrency exchanges received permission to do from the New York Department of Financial Services last week. Unlike bitcoin and ethereum, which are created through a mining process that also ensures the blockchain’s accuracy, these stablecoins are only created when someone buys them with U.S. dollars.

Gemini and Paxos have both established relationships with traditional banks to hold the U.S. dollars, while the exchanges, which have been granted licenses to function as trusts, are responsible for the tokens themselves. Instead of using computing power to audit the blockchain through the mining process, third-party auditors are employed to help ensure exactly as many tokens exist as there are dollars on account.

The benefit of these tokens is that while bitcoin’s price has fluctuated wildly (it's been as high as $20,000 and is currently at $6,480), making it almost impossible to spend, the U.S. dollar decreases in value on average at a rate of 2% a year, making it a much more reliable unit of exchange. On the flip side, while dollars may be stable, they’re notoriously slow for businesses to move in large amounts, especially given the relative ease with which an e-mail (or a bitcoin) can be sent.

From an investment perspective, the important part here is that the U.S. dollar-backed stablecoins are only as scarce as the dollar itself. As a result, getting your hands on one of these tokens won’t likely ever be a better investment than the U.S. dollar, and some have argued it may even be worse. The reasons U.S. dollar-backed stablecoins are being created aren’t to invest in but to enable off-hours trading and to jump-start transaction volumes on the underlying ethereum blockchain.

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But there are other, largely theoretical, ways to achieve price stability. The most popular of these is by coding some of the theories applied by central banks into the DNA of the blockchain. The most heavily funded of these blockchains that control price using an algorithm is Basis, which has raised $133 million from mainstream investors, including Andreessen Horowitz, to build a central bank for issuing cryptocurrency. In this case, when the price of the cryptocurrency starts to increase, the blockchain will automatically increase the rate at which it creates new coins, flooding the market and reducing the price. When the price starts to decrease, the Basis blockchain would buy back its own tokens, reducing supply and driving up price. Think of this alternative as an automated Federal Open Market Committee, where the 12 members are replaced by an algorithm.

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