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Stablecoins Are Not True Cryptocurrencies

Juan M. Villaverde
Last updated: | 4 min read

Juan Villaverde is an econometrician and mathematician devoted to the analysis of cryptocurrencies since 2012. He leads the Weiss Ratings team of analysts and computer programmers who created Weiss cryptocurrency ratings.

Source: iStock/sdstockphoto

Why we don’t rate Tether, TrueUSD and other stablecoins? We get this question all the time: You rate over 100 cryptocurrencies. Why don’t you rate Basecoin, Carbon, MakerDAO, Tether, TrueUSD, USD Coin and other stablecoins?

Our answer: True, their value is stable. Yes, they are digital. But they’re not true cryptocurrencies.

Stablecoins are simply digital assets acting as proxies for a particular fiat currency. That’s what makes them stable. But it also takes away any semblance of achieving the core mission of cryptocurrencies — to give the people a new form of money only they control.

Here’s how stablecoins work:

  1. The stablecoin issuers hold fiat money with a custodian. Usually it’s U.S. dollars.
  2. They create crypto tokens equivalent to the amount of fiat they’re holding.
  3. They fix the value of one token to the unit of the fiat money, such as U.S. $1.00.
  4. The token itself can be bought or sold on a crypto exchange. As long as it can be redeemed for the fiat currency, it should maintain its value in that currency.

True cryptocurrencies are vastly different because:

  1. Their value is not controlled — directly or indirectly — by any central authority.
  2. They can never be confiscated. Nor do they depend on fiat reserves that could be confiscated.
  3. They carry no counterparty risk. Even if one of the parties goes bankrupt, investors and traders are not left holding the bag.

These unique differences are the main reason cryptocurrencies, no matter how experimental, have attracted so many investors, engineers, mathematicians and speculators. They are the first asset class in history that’s …

  • purely digital AND
  • valued completely independently, regardless of any other asset values.

So …

Why are stablecoins needed?

Because, so far at least, the market price of true cryptocurrencies is too volatile. And as long as this continues to be the case, it will be extremely difficult for many distributed applications (dApps) to become mainstream.

Examples abound: Streaming video services. Ride-sharing services. Social media platforms. If their native coins can’t maintain some minimal level of price stability, average users simply won’t risk using them. Speculators may have a love-hate relationship with gyrating cryptos. But someone who’s trying to share a ride? No.

In the interim, Stablecoins offer an immediate, stopgap solution.

They’re a crutch for the dApp folks to lean on until crypto markets mature and stabilize. And that’s not a trivial use-case.

Here’s the rub: Unlike Bitcoin, Ether and other true cryptos, a stablecoin is more akin to an IOU — a promise to pay another asset in the future — not an asset that holds value on its own merits. If the issuer fails to hold an equivalent value in fiat with a custodian, the whole structure comes unglued.

Worse, if the financial system itself is destabilized, stablecoins could get swept by the tides. Much like a bank account, PayPal, Apple Pay or any other centralized fintech service. Which begs the question …

What’s the point of stablecoins using distributed ledgers in the first place?

Think about it.

Stablecoins use essentially the same Distributed Ledger Technology as true cryptocurrencies. But they only maintain their value if your counterparty holds assets in reserve and is willing to redeem the tokens for that asset. When you use a stablecoin, you have to trust them to do exactly what they promised.

See the contradiction? The technology that stablecoins use was designed to remove the need to trust someone else — not to require that trust.

So, imagine this scenario: The issuer stops redeeming your stablecoin for fiat. You protest, but there’s not much you can do about it. Your claim on the fiat is suddenly null and void. And the residual value of your stablecoin is a pittance compared to what you paid for it.

Does this type of thing really happen? In places or times of financial crisis, absolutely!

Just look at what took place recently in Venezuela. Officials of the embattled Maduro government tried to recall their gold reserves held at the Bank of England. But the BOE told them to go fly a kite. “In our book,” they said, “you’re no longer the legitimate rulers.”

We’re not siding with Maduro. But this incident highlights the soft underbelly of custodianship. When you store your assets with a custodian, if push comes to shove in a major crisis, physical possession enables them to take control. And if they cease to recognize your right to the property, you may have to fight it out in the courts or kiss it goodbye.

Ultimately, stablecoins are of the same ilk. They’re only as “stable” as the legacy system they derive their value from. In the long term, only true cryptocurrencies offer the promise of building a more robust, more sustainable structure.