Fundamental problem with all "stable" coins

"Stable" coin is a hot topic, Haseeb Qureshi had a great Medium blog post dissecting three types of "stable cryptocurrencies". Here's the link to his article. I will go over the pros and cons of all three categories later in this post, but Haseeb, and many other commentators are missing the point and so do all "Stable" coin designers. All of these coins have one characteristic in common: they all target a specific price. I assume the thinking goes: "if the price doesn't change much, that would make a coin stable". I think it is a big mistake. First of all, when a specific price is targeted that means that any time price moves away from that target, an organization tasked with maintaining the price stability will use their predetermined process to force the price in other direction. Historically that is how any price peg is maintained. And as we all know pegs have tendencies to be broken. It becomes a game of who has more resources, people that are trying to break the peg and people that are trying to defend it. George Soros is a poster child of peg breaking. Any time speculators feel that they have enough resources to break a peg they go for it. It's just a matter of time when a peg is attacked. When investors lose confidence in the peg or price stability that spells the end of that particular "stable" asset. But that is not even the main problem with targeting a specific price level.

Stability in itself should be viewed as a valuable resource, and the value of any market resource is changing based on the demand. When volatility is up or inflation increases (reduced stability in the world financial markets) demand for stable asset would increase, and when volatility is decreasing and there is no threat of a runaway inflation, demand for stability goes down. These market forces make stable assets more stable, it regulates its supply and makes such assets productive.

A great example of a stable asset is gold, and gold price moves around. It is determined by market forces and perceived stability of the global financial system. The dollar is another example. It's ironic that many stable coins are trying to target a price equal to one dollar, but the price of the dollar itself (as stable as it is) moves around against other currencies. Stability of the dollar or gold does not come from targeting a specific price. A dollar is relatively stable (compared to many other currencies) because it powers the US economy, biggest and most stable economy in the world. Gold is stable because it has a perceived value and that perception has been around for millennia.
Targeting a specific price actually makes stable cryptocurrency less stable. As demand for the stable assets is increasing or decreasing it put pressure on whatever stabilization mechanism that currency is using. Increasing stress on the stabilization process and cost of that stability.

As far as the three known categories of stable cryptocurrencies, there are examples of all three and many are viable and I am sure many more will be created. But all three have problems.

Cryptocurrencies backed by fiat currencies are probably the best know "stable" cryptocurrencies. Tether and TrueUSD are good examples of this category, but Tether specifically is used not because of it's stability, it is used as a US dollar substitute by many crypto exchanges. Exchanges are afraid of dealing in USD directly because they don't want to answer to US regulators and they all use USDT instead. As any asset-backed token, dollar backed currency is as stable as the dollar itself, as long and the relationship between the underlying asset and the token is transparent and safe. Even though Tether is in demand, the shortcomings of the dollar backed tokens are obvious, creating cryptocurrency backed by a fiat currency means that the coin's ecosystem has to be plugged into a traditional banking system to hold the underlying fiat currency at best with a centralized custodian. And the risk of that design is front and center in the Tether implementation. Tether cannot be open about where the dollars backing the currency are held without exposing itself to the wrath of US banking regulators. As a result, it's unclear who is holding the dollars for Tether and how much of it is there. One call from US regulators to any bank that is doing business with Tether and that relationship is gone.

A good example of a "stable" coin backed by crypto collateral is Dai by MakerDAO. The market cap is growing, it stands just over 40mm USD. Dai seems to be pretty stable so far, but to achieve that stability, Maker is over collateralizing its tokens. That process makes the stable currency expensive and whether it will be able to significantly grow its market share remains to be seen.

The last and my favorite (I am being a little facetious here) category is "stable" currencies with stability provided by an external resource or an economic schema where some other resource (usually a second coin) is used to maintain the stable price of the first one. Basis (formally known as Basecoin) would be a good example. It is unclear how this coin will behave, especially at the time of a significant market stress. I view these systems as artificial, and ultimately, artificial systems use external resources to maintain stability. Investors have to trust that participation in these type of dual coin models will be profitable. The second this trust in an outside resource or a dual coin structure is gone these type coins would collapse. Resources have a tendency to run out and I think at a time of some market crisis these type of tokens will not do well. I may be proven wrong, time will tell.

So how can a stable cryptocurrency be created, or what could make a cryptocurrency stable? In short, a truly stable cryptocurrency has to have its own stability and not rely on another asset or another coin to maintain its price. A stable crypto ecosystem has to be created and a cryptocurrency that is an integral part of it will be as stable as the ecosystem itself. Both Bitcoin and Ethereum ecosystems are growing and gaining stability, these currencies won't be viewed as stable in comparison to gold or dollar any time soon but they are gaining stability. As a number of market participants increase these currencies will be less volatile and more stable. Stable ecosystems mean there is a stable demand for the currencies, not just from traders and speculators. The current value of these two and other cryprocurrencies is based purely on real or perceived demand generated by investors entering the crypro market. The influx of new market participants is significant and for now, it doesn't add to the stability of these cryptocurrencies.

So, what will a real stable cryptocurrency look like? Here's my list of attributes:

1. It will run on its own blockchain that is a well understood and safe
2. It will support a large ecosystem with a stable and significant number of the daily transactions.
3. The value of this currency will have a direct correlation to the size of its network
4. It will not be backed by any other asset
5. The price of this currency will be allowed to fluctuate based on supply, demand, market sentiment, etc.
6. The value will not depend on gimmicks like token burning, etc.

Fungible Network is working on such currency. We believe it will be the first cryptocurrency where stability will be a byproduct based on real returns the currency can generate for its holder.

STAY TUNED!