In a space notorious for mercurial price swings, stablecoins stand out as a fascinating bridge between traditional finance and the volatile coins that have made cryptocurrency famous. Interestingly enough, stablecoin issuance may represent a profitable venture for individuals and businesses with enough knowledge, capital, and finesse.
If you are considering creating your own stablecoin, though, you’ll want to do as much research as possible before issuance. To help you in that process, this article offers a list of 5 things to know before you create a stablecoin. If you have any further questions, reach out today.
Stablecoins: The What, Why, and How?
Before we move onto the more specific and urgent things you should know before you create a stablecoin, it will help to cover the basics of stablecoins. That’s what this section is for.
What are Stablecoins and What Purposes Do they Serve?
As the name suggests, stablecoins are cryptocurrencies unlike most other cryptocurrencies due to their lack of volatility. While other cryptocurrencies are likely to fluctuate in value wildly on a regular basis, it is the goal of stablecoins to maintain their prices; people do not buy stablecoins with the hope of profiting from them.
After learning that stablecoins are not meant to gain value over time, many people will wonder, “Then what’s the point?” Actually, stablecoins serve a number of purposes. These two purposes, specifically, are particularly important and useful.
- Stablecoins facilitate cryptocurrency trading. Let’s say you want to buy Bitcoin right now but you don’t currently have any cryptocurrency or funds already on an exchange. You’d need to transfer funds to an exchange account first, then use them to buy Bitcoin. Stablecoins provide an easy and convenient intermediary for such situations. Since Tether (USDT) is “pegged” to the US dollar, you could buy Tether and keep it in your account for any time you wish to buy other cryptocurrencies.
- Stablecoins are perfect for quick and easy cash transfers. While facilitating crypto trading is the most obvious and often discussed purpose of stablecoins, it is this second purpose that threatens to disrupt the financial world most immediately.Cryptocurrency excites so many people because it is seen as an improvement over traditional methods of payment and transfer. For the simplest example, performing a bank wire transfer is slow and expensive when compared to the transfers that many cryptocurrencies allow. If you wish to transfer someone money for goods or services, though, many people may not be willing to accept crypto due to volatility. Stablecoins are perfect for scenarios like this; they offer the ease of transfer of other cryptocurrencies without the volatility.
How do Stablecoins Achieve and Maintain Stability?
There are three different ways that stablecoins can remain stable:
Collateral-backed stablecoins are by far the most widely known. These stablecoins “peg” their value to other assets with the goal of never deviating from their prices. For example, there are stablecoins pegged to a variety of fiat currencies, precious metals, cryptocurrencies, and even crude oil. In theory, holding these stablecoins should be no different from holding the asset they’re backed by.
Examples: USDT, PAGX
Stablecoins which are not pegged to real-world assets utilize algorithms to reach and maintain stability. The algorithms that maintain stablecoins are designed to adjust supply by increasing or decreasing tokens to keep their price stable despite changing market conditions.
As you might guess from the term “hybrid,” these stablecoins utilize aspects of both collateral and algorithms to achieve the goal of stability.
5 Things to Know Before You Create a Stablecoin
With a thorough background of stablecoins established, we can safely proceed to the main purpose of this article: the 5 things you should understand prior to issuing your stablecoin.
1. Stablecoins Face Increased Regulations
The early success and obvious promise of stablecoins are quite threatening to traditional institutions and those who are less welcoming to crypto, in general. Put simply, if stablecoins continue their trajectory and become more attractive than established fiat currencies to the general public, traditional institutions could have a large problem on their hands.
With this looming issue in mind – as well as some of the dangers of Stablecoins (which we’ll cover in consideration #2) – regulators have become more active and vocal about imposing stricter guidelines on stablecoins.
Although regulations have not been implemented on a large scale, it is clear that they are planned and coming in the near future. The following list represents a brief and very limited summary of some regulatory rumblings regarding stablecoins:
- September 2020: FinCEN director declared that stablecoins fall under the “money transmission” umbrella and must comply to pertinent regulations, including Anti-Money Laundering
- December 2020: US congress members proposed the STABLE (Stablecoin Tethering and Bank Licensing Enforcement) act to impose guidelines on stablecoins.
- July 2021: The President’s Working Group for Financial Markets met with President Joe Biden to discuss stablecoins specifically, with regulations in mind.
Again, this list is quite abbreviated. The point is that regulatory bodies and other world leaders are well aware of stablecoins and taking steps to put them on as short of a leash as possible. In some ways, this is a good thing as it may decrease risks for all parties. In other ways, it may inhibit the freedom that characterizes cryptocurrency.
2. The Dangers of Issuing a Stablecoin
While the regulations explored in consideration #1 pose a threat to all issuers of stablecoins, they should be understood and expected. The dangers that we’ll discuss in this consideration aren’t nuisances or hurdles – as regulations can be – but potential stablecoin killers. Before you create a stablecoin, you need to know these dangers in and out.
Let’s go into the future a bit and imagine that you’ve succeeded. You’ve issued a stablecoin and it’s been well-received by a large audience! If you haven’t already looked into the potential issues that can arise for stablecoins, you might think that managing one would be easy. They’re stable, after all. Unfortunately, this isn’t the case. If stablecoins are mismanaged or neglected in any way, catastrophes can occur.
Understand “Runs” and Safeguard Against Them
Perhaps the most significant danger of stablecoin issuance is that of a “run.” In traditional finance, a “run on a bank” is one of the worst things that can happen to a brick and mortar banking establishment. Runs occur when a bank’s customers worry that their bank will fail and withdraw their money en masse. If the bank doesn’t have enough cash on hand to fulfill the requested withdrawals, the bank faces the risk of bankruptcy.
The same thing can happen to stablecoins. For this reason, it’s absolutely imperative that reserves of collateral are sufficient and safely held.
Protect Your Stablecoin from Technical Issues
Especially if you’re issuing an algorithmic stablecoin that is non-collateralized, technical issues present serious threats to daily functioning and public confidence. Of course, technical issues are hazardous for anyone with any sort of cyber component to their business, but it must be understood that cryptocurrencies are especially vulnerable.
While the term “technical issues” mostly refers to glitches and problems in the code of a stablecoin, we can also place cybersecurity and the threat of hacking into this category. The unfortunate truth is that cryptocurrencies can be and often are targeted by malicious hackers that attempt to exploit weak code for profit.
The best way to defend against technical issues – malicious or otherwise – is iron-clad cybersecurity and rock-solid code.
3. Stablecoins Can Be Issued on a Variety of Platforms
Stablecoins, like other cryptocurrencies, utilize blockchain technology and are launched in the same way that other cryptocurrencies are. To date, we’ve seen many Stablecoins issued using Ethereum’s technology. There are other options, though. Specifically, Tron and EOS are also known as platforms capable of supporting stablecoins.
Weighing the pros and cons of the platform you will utilize for issuance is a mandatory step of creating a stablecoin. Before you go about making your decision, be sure to explore all of your options and assess each of them based on things like cost, scalability, and interoperability.
4. The Reputation of Your Stablecoin is Critical
For people to trust your stablecoin enough to utilize it, especially when there are other already established alternatives, the reputation of your offering is of utmost importance. Individuals choosing stablecoins want to know that your stablecoin lives up to its promises. Specifically, it should have:
- Sufficient Liquidity
- Adequate Reserves and/or Effective, Reliable Algorithm
In your efforts to bolster the reputation of your stablecoin, you may choose to voluntarily undergo audits. An audit of your operations will have third party authorities investigate the inner workings of your stablecoin, specifically with regards to smart contracts, reserves, and procedures. Successful and documented audits will show the general public that your stablecoin is legitimate.
5. Even the Most Respected Stablecoins Can Fail
Before you issue your stablecoin, reading up on past stablecoin failures and understanding why they occurred is essential.
In early May, 2022, a huge drop in value for the cryptocurrency market saw stablecoins struggling to keep their stability. Most notably, Tether faltered and Terra failed. These significant difficulties do not make stablecoins impossible or unviable. They do, however, serve as a reminder that nothing in crypto – or life – is guaranteed.