By Slobodan Sudaric, partner of the Protocol Economics team at cLabs, working on Celo
Around the world, inflation and slow, expensive transactions have been the norm in traditional financial systems for decades. That is to say until the emergence of crypto-currencies. When Bitcoin and its successors entered the scene, they created a new, faster and cheaper alternative to traditional payment systems by removing the need for third-party intermediaries. The fixed supply of tokens of some cryptocurrencies has even offered a response to the inflation plaguing fiat currencies.
As is the case with most inventions, however, when one problem was solved another took its place. While cryptocurrencies were faster and cheaper to trade than their fiat predecessors, their price action was also more volatile. How reliable is a currency if its value can triple or halve in a matter of hours?
Yet every problem has a solution, and that’s how stablecoins came to be.
Stablecoins first appeared on the cryptocurrency scene in 2014, designed to protect users from the volatility of cryptocurrencies like Bitcoin and Ethereum by tracking the value of an underlying asset. Their stability allows them to function as a more reliable medium of exchange and a store of value.
Stablecoins are typically backed by a pool of assets or a basket of assets. For stablecoins backed by trust funds, the stablecoin issuer typically holds a value of fiat currency in cash or other high liquidity assets equivalent to the number of coins issued to track it. Users can exchange a stablecoin for a unit of currency at any time, but they should be confident that the issuer will not mishandle or misreport its reserves. Popular stablecoins backed by trust funds include Bitfinex’s Tether or Circle’s USD coin which both track the value of the US dollar.
In contrast, for crypto stablecoins, the reserve holds its assets on a public blockchain, making it fully verifiable and removing the need for stablecoin holders to trust the issuer. Users exchange stablecoins by interacting with a smart contract that programmatically exchanges stablecoins for reserve assets at the user’s request. Examples include the US dollar tracking Dai coin on the Ethereum blockchain or the cUSD and cEUR coins on the Celo blockchain.
Stablecoins initially struggled to gain traction due to a lack of transparency, long transaction times, high costs, and limited access compared to other cryptocurrencies. However, as developers overcame these hurdles, stablecoins began to experience wider adoption, surpassing a total circulating supply of $ 100 billion in 2021. This adoption was driven in particular by use cases in transactions and decentralized finance (DeFi).
As with other cryptocurrencies, transactions involving stablecoins benefit from the decentralized nature of blockchain technology, eliminating middlemen like banks and payment providers. This provides a fast and inexpensive alternative to traditional transaction channels.
Transactions using stable coins can cost as little as a fraction of a dime, regardless of their value, and are usually processed within seconds. In comparison, most traditional payment providers charge a fixed fee plus an additional 1.5% to 3% for each transaction.
Another advantage of blockchain technology is that it reduces counterparty risk by eliminating the middleman. The sender and receiver transact directly with each other rather than through a third party, which removes a potential point of failure, an extra step in the transaction and, with it, a cost additional.
Stablecoins also provide an affordable way for users to send money across borders. To put this in context, sending $ 200 in stablecoins can cost less than a cent, compared to a worldwide average charge of $ 12 depending on the. world Bank, reaching over $ 30 in some countries.
Stablecoins enable targeted, rapid and cost-effective distribution of humanitarian and environmental aid. In June 2020, a non-profit organization called the Grameen Foundation launched a project to send emergency cash relief to women entrepreneurs in the Philippines. Providing aid, however, was a challenge given measures to tackle the global Covid pandemic, so the foundation used Celo stablecoins to send nearly $ 160,000 in financial aid to more than 730 beneficiaries. Recipients spent the money through a personalized microsite selling groceries and essentials.
The world is gradually moving towards an economy of odd jobs, especially in developing countries which generally have large informal labor markets. Meanwhile, improved connectivity has created opportunities for micro-work, giving people the option of earning a full-time living or supplementing their pay with side jobs. However, microwork payments are generally low, making low-cost solutions that use stablecoins a suitable compensation option.
Decentralized finance (DeFi)
Stablecoins allow users to access a new generation of financial products, traditionally only available from banks, from their mobile phones. These products, which generally fall under the decentralized finance (DeFi) ecosystem, are particularly important in countries with underdeveloped financial infrastructures, which makes it difficult to open a bank account or apply for loans. or loan facilities.
By converting local currency into stable coins, users can protect their income and savings from the risk of hyperinflation which is rapidly eroding the value of fiat currencies.
Hyperinflation remains a concern for millions of people, with inflation rate in some countries exceeding hundreds or even thousands of percentage points in 2020. Take Zimbabwe, for example. Prices could increase by around 100% this year, which is an improvement from the 550% increase in 2020. Elsewhere, Argentina faces more than a decade of double-digit inflation with rates currently between 40% and 50%.
In countries with low inflation, such as the EU and the United States, stablecoins can help prevent savings and erosion of income. The European Central Bank’s deposit rates are currently negative, and commercial banks pass these costs on to their customers, either as negative rates or as increased fees. However, euros held as stable coins are not exposed to these rates, nor, for that matter, to the exchange risk linked to the conversion of euros into other fiat currencies.
On platforms like Aave Where Moola Market, users can earn on stablecoins they lend or borrow stablecoins if they do not want to sell their holdings. Loan rates depend on demand for a coin – they increase when demand increases and decrease when demand decreases. Borrowers can provide another crypto asset as collateral to continue to hold that asset, but they face liquidation risk if the value of the collateral drops, leaving the unpaid portion of the loan unsecured.
In traditional markets, assets are traded through order books on centralized exchanges that determine clearing prices based on supply and demand. Decentralized exchanges (DEX) such as SushiSwap Where Ubeswap remove the need for an intermediary. Instead, users trade directly against cash pools, a collection of coins held in a smart contract on the blockchain. DEXs use an algorithm to adjust the price of an asset based on the inflows and outflows of the pools, but they can only execute trades if the pool has sufficient liquidity. That is why they offer incentive payments to liquidity providers. There are risks, however, especially when coins supplied to pools are volatile. Volatility can lead to short-lived losses, where losses can be recouped if prices swing in the opposite direction.
There are many use cases for stable coins. Compared to traditional financial systems, they allow faster and cheaper transactions and can offer protection against inflation. They inspired a suite of new financial tools designed to help users give, earn, save, lend and trade their assets. Stablecoins provided a gateway to financial systems for millions of previously unbanked people around the world in just the first decade after their invention, making them among the most important financial tools to watch in decades to come. to come.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.