GOLD: An Alternative Solution to Fiat-based Stablecoins

PolinaCryptoN

Hi again! Welcome to another exciting topic. Today, we discuss the overview of stablecoins by taking the Digital Gold Stablecoin as an example. Have you heard about Digital Gold? Digital Gold is an Ethereum-based ERC20 token. It is a stablecoin, but it is somewhat different from traditional fiat-based stablecoins. A Gold Token equals 1 gram (approximately 99.9%) of real gold as in the following equation.

Imagine that the current price of 1 gram of real gold is $50. Then, 1 gold token is worth $50 approximately. So, the price of a gold token is fixed as the price of 1 gram of real gold remains fixed. That is why we say that the Gold is a stablecoin. Gold is stable relative to the real gold, but TUSD or USDT is stable relative to the real USD ($). That is the difference between the Gold Token and other fiat-based stablecoins.

OVERVIEW OF STABLECOINS

Digital assets are notoriously volatile. The volatility of bitcoin (BTC) has been declining as compared to earlier periods in the cryptocurrency’s now nearly 10-years in existence. However, for the foreseeable future, it is likely to remain more volatile than well-managed national currencies, as well as physical commodities like the one it is most frequently compared to gold.

To be clear, bitcoin’s volatility from the perspective of many market participants is viewed as a positive characteristic. Indeed, contrary to the view expressed by experts in the field, bitcoin has demonstrated that millions of people would prefer to hold a currency that has the potential for price appreciation over one that is relatively stable. In short, bitcoin’s volatility has proven to be a ‘feature’, not a ‘bug’. However, this feature is also preventing cryptocurrencies from realizing their full potential as an alternative means of payment and unit of account in the broader economy, and many feel the solution to this problem will come from stablecoins.

What is a stablecoin? (A Detailed Definition)

As the name suggests, a stablecoin is a cryptocurrency that has been designed with the aim of minimizing price volatility. Digital Gold is an example of such a coin. Most stablecoins have been designed to be equal to the US dollar, the world’s leading reserve currency. For example, a single currency unit of the largest stablecoin, Tether (USDT), is intended to be equal to one US dollar, and for the roughly three years that Tether has been actively traded in the public cryptocurrency markets its exchange rate has proven to be generally reliable in delivering on this design objective. Digital Gold has been designed to be equal to the price of 1 gram of real gold.

Why use a stablecoin?

Stablecoins can provide a critical infrastructure layer for the digital assets ecosystem. A highly volatile cryptocurrency such as bitcoin may be inappropriate or even unusable in certain circumstances, and for a number of products and services. For example, if someone is living paycheck-to-paycheck and needs to make a regular rental housing payment each month, that person would be ill-advised to hold the funds needed for this payment in a currency as volatile as bitcoin. At the same time, if you are bullish on bitcoin’s ‘digital gold’ investment thesis, and you believe it will continue to appreciate and successfully store value over time, then using bitcoin for everyday purchases may be psychologically unappealing. In both of these examples, a stablecoin, serving respectively as a store of value and medium of exchange, could be preferable for use. Another important point to emphasize is that stablecoins are simply price-stabilized cryptocurrencies, meaning they incorporate many of bitcoin or ether’s most compelling features: programmability (e.g., smart contract integration), efficiency (e.g., low-to-zero transaction fees, fast settlement times), fungibility, open (i.e., permissionless) access, and so on.

Main Stablecoin Design Types

Stablecoins are one of the categories that best illustrate the tremendous creativity and innovation underway in the digital economy. A wide variety of different stablecoin designs have been developed and released to date, but broadly all stablecoins can be characterized as either a) ‘asset-backed’ and b) ‘algorithmic’.

An asset-backed stablecoin design is one where some asset, most often US dollars but increasingly crypto assets like ether (ETH), is held in reserve with the aim of supporting the stablecoin’s exchange rate. Digital Gold is an asset-backed stablecoin.

In contrast with asset-backed designs, algorithmic stablecoins employ a set of rules expressed in software code that attempt to match the supply of the stablecoin with demand. An important point to note here is that there have been, in contrast, algorithmic stablecoins have yet to launch. Of these two types of stablecoins, asset-backed has been the more popular to date, and represent 77% of all stablecoins. Further, some algorithmic stablecoins as part of their rollout strategy also incorporate asset-backing. Generally, asset-backed stablecoins are easier to bring to market and simpler in their design, particularly when they are ‘traditional asset-backed’ (eg USD, gold).

Further, it is unlikely than a single design is optimal for all use cases. In other words, which stablecoin is ‘best’ depends upon a wide variety of sometimes competing factors, including:

Intended use (e.g., short-term trading store of value)
Degree of desired trust minimization and decentralization
Regulatory/jurisdictional compliance
Scalability

USE CASES

Stablecoins can be employed for many of the same use cases as other cryptocurrencies like bitcoin, with the added benefit of price stability. Whether or not price stability is desirable or a worthwhile tradeoff will depend on the individual context and circumstances, but the crucial point to understand about stablecoin use cases is that many of them are multi-trillion dollar opportunities. In other words, there is stablecoins have the potential to grow into one of the largest, if not the largest, digital asset categories. Some use cases of stablecoins including Digital Gold are:

Medium of Exchange

At present, any business would take a significant risk of accepting cryptocurrencies as a medium of exchange due to the significant volatility of this asset class. Stablecoins hold the potential to help unlock the use of cryptocurrencies for day-to-day payments for businesses and commerce as price stability is a key missing element for the adoption of cryptocurrencies by merchants and retailers all over the world. Companies need a degree of certainty about their short-term cash reserves and revenues. Transacting in ether or bitcoin would make the role of a treasurer a difficult task as the business’s runway (how long the company can survive if income and expenses stay constant) could adversely shift in an instant due to unfavourable market swings.

dApps

In the web 3.0 stack, decentralized applications (“dApps”) are being built on top of infrastructure protocol layers. Many of those applications will likely rely on price-stable cryptocurrencies to distribute value. Stablecoins should accelerate the shift from token speculation to usage in dApps as users won’t be incentivised to hold (or sell) the token in anticipation of future price appreciation (or depreciation). This should, in turn, increase the token velocity and fulfil the potential of decentralised networks. dApps are the channel through which stablecoins are likely to be brought to the masses in the foreseeable future.

Store of Value

A store of value is a commodity, asset, or money that retains its purchasing power or value into the future. Some view crypto assets including bitcoin as too volatile to be commonly accepted as a store of value. Some companies need to hedge themselves over the long-term. For example, miners are currently highly exposed to the price of the crypto asset they receive in return for computing resources. A stable reserve of liquid assets is needed to cover one-off additional fixed costs (such as purchasing hardware) and on-going variable costs (such as electricity). In the current crypto ecosystem, volatility risk is currently being highlighted in fundraising via Initial Coin Offerings (“ICOs”). Projects generally raise a given amount of ether to allocate resources in order to deliver on their promises. Due to the high level of friction associated with converting crypto assets into fiat, founding teams tend to hold most of their funds in ether. In a bear market associated with falling prices like the present one, management would have to meet investor expectations while suddenly having less capital at their disposal. Stablecoins could thus help founding teams of ICO projects manage their funding more safely over the long-term.

Remittance

Stablecoins eliminate price volatility risk as crypto payments are being processed. To stay relevant in this context, transactions would have to be confirmed rapidly (ideally in a matter of seconds) to provide a good user experience and a noteworthy improvement compared to transfers relying on the current underlying banking infrastructure (international banking transfers currently take up to three days).

Find out more about Digital Gold

Disclaimer: The information presented in this article is for information purposes only and should not be construed as financial or any other advice.

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