Keeping Digital Assets Stable With Stablecoins

INTRODUCTION

The recent stratospheric rise of bitcoin and its compatriot altcoins has generated both intrigue and despair as a handful of big-name digital assets reached new apogees in 2021 with respect to price and market capitalization.

In the case of intrigue, outperformance of and familiarity with bitcoin et al has led to fruitful discourse as well as interest by a plethora of Institutional Investors to start building allocations to digital assets (see the following CAIA infoseries for more on the discussion as to whether cryptoassets are indeed ready for Institutional Investors). Conversely, in the case of despair, the volatility of digital assets, regardless of how one measures it, has served as the proverbial “worst enemy” of cryptocurrencies and perhaps the most salient detractor for more widespread adoption. After all, it is hard to count on using an asset as a viable medium of exchange if its value or even a store of value if prices fluctuate wildly over a broad spectrum of time intervals and market conditions. Moreover, the parabolic rise of any asset tends to exacerbate the volatility problem by keeping traders consistently unsettled with one eye towards the metaphorical exit, trying to time their serendipitous withdrawal before the next drawdown.

Keeping Digital Assets Stable with Stablecoins

In the backdrop, however, is perhaps one of the key lynchpins to stymieing volatility and the despair that often accompanies it: stablecoins. The purpose of this research note, therefore, is to provide investment professionals a cursory understanding of a financial innovation within the cryptocurrency milieu that will likely receive more and more attention as investors of all stripes look for ways to garner digital asset exposure.

OVERVIEW: WHAT IS A STABLECOIN?

As the name implies, a stablecoin is a cryptocurrency whose price is stable—as in steady or fixed—and whose value is pegged to a secure asset such as a fiat currency (e.g. 1 unit of stablecoin is equal to 1 USD) or Commodity (e.g. 1 Unit of stablecoins is equal to the price of a gram of Gold) [1]. To achieve the said stability, different protocols or methodologies—discussed below in more detail—are utilized by issuers of stablecoins. To see just how “stable” relative to their espoused $1.00 peg stablecoins are, Exhibit 1 displays the price history of the top 5 stablecoins by market capitalization. [2]

From an application standpoint, stablecoins aim to bridge the divide between the digital asset world and the fiat currency world by offering users and investors a way to have their proverbial cake and eat it too: curbed volatility coupled with the benefits provided by the decentralized, secure, transparent, and quasi-anonymous payment system afforded by blockchain technology and cryptocurrencies.

At the time of this writing, the stablecoin market has grown precipitously since its genesis in ~2014 thanks to an increased number of offerings, regulation, and better supporting infrastructure. Albeit, far from the market capitalization of BTC and ETH, stablecoin’s market Capitalization has—notably–exceeded $33bn with Tether, a fiat-backed stable coin holding the third highest market capitalization across all cryptocurrencies, exceeding other big name cryptos such as LTC and Cardano. Exhibits 2 and 3 provide additional context on the composition of the Stablecoin Market as of 1/13/2021. [3] [4]

Exhibit 1: Price History of Current Top 5 Stablecoins by Market Capitalization relative to $1.00 peg

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