Why do we need stablecoins?

Source: From Wang Jian's perspective

01 What is a Stablecoin

Stablecoins are a type of monetary system design that is distinct from both fiat digital currencies and cryptocurrencies. Here, we have used a somewhat awkward term "monetary system design" because we are still unsure whether it can be considered a true form of currency.

A typical stablecoin mechanism is (referring to the scheme in Hong Kong, China. Schemes in other places may vary):

The issuer (private sector) reserves a certain amount of real assets (domestic or foreign fiat currency, or other credible financial assets such as government bonds, precious metals, and may also include cryptocurrencies) to issue a certain amount of stablecoins backed by 100% of one or a group of real assets, and then this stablecoin is traded on a distributed ledger.

Note a few points:

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

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

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

This plan ensures that stablecoins will not be overissued, as every unit of stablecoin is backed by real asset reserves, and the holders of stablecoins can redeem reserve assets from the issuer at any time. If the reserve assets are fiat currency, then it can ensure that the credit of the stablecoin is basically consistent with that of the fiat currency.

Moreover, if the reserve assets are set as a combination of multiple assets, it can also offset the value fluctuations caused by significant volatility of a certain asset.

Stablecoins then operate on a distributed ledger, allowing them to enjoy various benefits of a decentralized system, such as: limited anonymity (market participants cannot spy on others' transactions, but judicial or regulatory authorities can under necessary procedures), difficulty of tampering, and the inability to kick someone out (like the kicking operation of certain payment organizations), etc. Moreover, the peer-to-peer transactions on a distributed ledger naturally transcend national borders, making it inherently an international payment settlement mechanism.

02 Characteristics of Stablecoins

The earliest stablecoin, USDT, was launched by Tether in July 2014 and officially traded on exchanges in February 2015. The reserves behind it are in US dollars, and it is currently the largest stablecoin in the world.

The original intention of USDT was that cryptocurrencies represented by Bitcoin were in high demand in the market, but their value fluctuated greatly, making it impossible to fulfill the functions of currency. Therefore, a currency was designed to correspond 1:1 with the US dollar and run on a decentralized distributed ledger like a cryptocurrency.

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

From the perspective of the 1:1 setup with the US dollar, it resembles a token of the US dollar, which has simply integrated into a decentralized distributed ledger to facilitate usage for everyone. Later, the reserve assets of USDT became diversified, incorporating cryptocurrencies, gold, corporate bonds, and other assets. Among the dollar reserves held, there are not only deposits but also US Treasury bonds.

The diversification of reserve assets can also alleviate concerns about the fluctuations in the value of fiat currencies. After all, during those years, in addition to the significant volatility of cryptocurrency values, policies like quantitative easing implemented by some countries led to worries about the value of fiat currencies.

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

At this time, more and more formal financial institutions and companies are beginning to accept stablecoins, such as for payments in trade. Additionally, there are some investors internationally who treat stablecoins as an investment or savings tool, as they correspond to a basket of good assets.

If a new thing truly has its value and challenges regulation, then the best response is to incorporate it into a regulated framework. In recent years, several countries and regions have begun to formulate regulatory measures to standardize the operation of stablecoins.

03 The Future of Stablecoins

Now multiple countries and regions are beginning to regulate stablecoins in a standardized manner and have launched their own stablecoin schemes. Due to the natural cross-border attributes of stablecoins, various stablecoins will compete on the international stage in the future, vying for user adoption.

Firstly, stablecoins are used for cross-border payment settlements, challenging the traditional centralized methods of payment settlement. The most classic method of cross-border payment settlement is centralized, similar to "SWIFT + clearing institutions", but it has issues such as high costs, low efficiency, and susceptibility to political interference. The multilateral digital currency bridge (using central bank digital currencies) is a recently emerged decentralized solution, currently in a rapid development phase. Stablecoins represent a completely new idea, which seems to have strong advantages in many details, but poses significant challenges to regulation, and there are still many regulatory issues that need to be addressed.