The relative stability of stablecoins: Part 1

Stablecoins now offer a path to upgrading traditional payment systems

by Garima Parakh

Stablecoins now offer a path to upgrading traditional payment systems, though they were originally created to be crypto-native, permitting price arbitrage and ease of movement across crypto exchanges. Stablecoins differ from traditional deposits in two ways - cryptographic security and operating on distributed ledger technology (DLT) platforms that can be programmed for composability. Cryptography enhances transaction speed and public blockchains are unencumbered by clearing agents enabling transactions 24x7 throughout the year. The interoperability advantage helps integrate stablecoins with traditional payments and financial services via smart contracts. The most widely used stablecoins are centrally issued (eg Tether) and backed by real assets ranging from fiat currency and Treasury bills to receivables and other cryptocurrencies. In bridging the gap between the cryptocurrency market and the traditional market, stablecoins are pegged to a fiat currency (usually the US dollar). The peg can be maintained through posting collateral deposits or smart contracts programmed to defend the peg when it risks falling below the 1:1 ratio. A considerable percentage of decentralised finance (DeFi) transactions use stablecoins for lending, borrowing and investing, with US$766 million worth of stablecoins being transacted. ¹ Wider adoption of DeFi will also integrate stablecoins into the real economy as they have stable exchange rates compared to other virtual currencies (VCs). Stable values reduce information asymmetries that are otherwise a function of other VCs.