10th September 2021
Introduction to Stablecoins
Stablecoins are a type of cryptocurrency that is built to offer more stability in prices than other cryptos because it is backed by assets like the U.S. dollar or gold. Unlike other cryptos, such as bitcoin which aren’t pegged to a stable asset; their value is derived from a combination of peer-to-peer technology and software-driven cryptography. The table below lists the 5 largest trading stablecoins by market capitalization as tracked by CoinMarketCap, a cryptocurrency data, and analytics provider.
How do stablecoins work?
Stablecoins are backed by multiple sources, including fiat currency (meaning traditional currencies like the US dollar or Australian dollar in your bank account), other cryptocurrencies, precious metals and algorithmic functions. Of course, the backing source of a stablecoin can impact its risk level: A fiat-backed stablecoin, for instance, may be more stable because it is linked to a centralized financial system, which has an authority figure (like a central bank) that can step in and control prices when valuations are volatile. Stablecoins that aren't linked to centralized financial systems, like a bitcoin-backed stablecoin, may change drastically and quickly in part because there is no regulating body controlling what the stablecoin is pegged to.
Why do People use Stablecoins?
Stablecoins are built to withstand volatility in a way that other cryptocurrencies aren't, but still offer mobility and accessibility. A more stable cryptocurrency that is decentralized, meaning it isn't beholden to the rules and regulations of a centralized system, is attractive for other reasons: Faster money transfers, access to financial services without applications, keeping financial data private and avoiding financial service fees. Stablecoins may not be the investment that other cryptos are: They are inherently built to keep their prices stable, not soar in value. For example, the USD coin has barely strayed from its $1 value for its entire existence. Meanwhile, at the start of 2019, bitcoin floated close to $4,000, but in May 2021, it was over $60,000. Stablecoins may be better used as a form of digital cash rather than a speculative investment.
Afterpay’s plans to adopt stablecoins and potential regulations
An example of how stablecoins is utilised as a cryptocurrency to facilitate financial transactions may be attributed to Afterpay. With its consideration in adding crypto to its new Afterpay Money app as a response to burgeoning consumer interest in alternative currencies, Afterpay holds that blockchain technology will cut costs by removing intermediary banks associated with payment cards. In other words, this institutes a ‘single transaction fee associated with validating the payment on the blockchain’ instead of the various fees such as interchange fees, scheme fees and processing fees under the traditional method.
Afterpay prompts the central bank and the government to create regulation for an Australian dollar “stablecoin” to facilitate payments outside the existing system. A stablecoin is pegged to the Australian dollar and is less impacted by the same volatility as regular digital coins. Apparently, Afterpay would benefit from this as it expects to increase profitability by cutting scheme fees as the merchant-of-record for the transactions it processes.
However, the implementation of stablecoins into a central bank digital currency is not without its caveats. Namely, there arises a need for regulation of stablecoin by its private issuers. As noted by Afterpay’s head of public policy, there is work to be done to ensure a safe and efficient regulatory environment. Afterpay recognises “novel risks” for consumers including the loss of digital keys, burned transactions and complexity. Furthermore, private players in a foreign jurisdiction would manipulate an Australian dollar-backed stablecoin outside the regulatory perimeter.
As a result, Afterpay seeks to collaborate with the Australian government to adopt regulatory instruments for stablecoin issuers to have transparent and adequate reserve holdings, consumer-focused data protections and to provide stablecoin purchasers with greater protections over the value of their asset. This ensures that as stablecoins and blockchain continue to grow, Australia’s position as a global fintech leader will thrive.
The views expressed within this article are those of the authors and do not represent the views of the Finance Student's Association. All images and references in this article are for fair and educational purposes only. The content in this article is not intended as legal, financial or investment advice and should not be construed or relied on as such.