Two firms, Paxos and Gemini (backed by the Winklevoss twins of Facebook fame), received regulatory approval for their stablecoin this week. What are stablecoins and why does this matter? Should you invest in them? Let's take a look.
What Is a Stablecoin?
A stablecoin is a cryptocurrency pegged to a more stable asset like gold or even fiat currency. Fiat currencies do this too. The Hong Kong Dollar is pegged to the USD. By far, the most well-known stablecoin is Tether, which is tethered or backed by USD. The result is that the price is always at or near $1 to buy 1 Tether. Tether is controversial as many believe they don't own the USD necessary to peg its coin and they have not gone through an audit to show what assets they do have. Tether makes money from charging a fee for purchases and interest earned on the money held.
Since the stablecoin is pegged to a stable asset but its digital and cryptography protected, it is often used for providing payments for goods. They are far less volatile than even the largest cryptocurrency, Bitcoin. No one wants to pay 20% more for their morning coffee because their cryptocurrency moved against them overnight. Stablecoins don't have this issue. This lesser volatility is a huge selling point for stablecoins as well as the liquidity providing a bridge between fiat and cryptocurrency or moving cryptocurrencies across exchanges.
Other financial uses like securities settlement, swaps, options or other derivatives are examples of cases where a stablecoin might be the right tool for the job thanks to its liquidity and low volatility.
The 2 Newest Stablecoins: Paxos & Gemini
Although stablecoins are usually backed by a stable asset like gold or the USD, the Paxos coin is a stablecoin backed by Ethereum (ETH). The approval from the NY Department of Financial Services (famous for the restrictive BitLicense) means this will be a regulated compliant coin. The coin called the Paxos Standard (PAX) will be issued by a trust company and will be an ERC-20 token. ERC-20 is the type of almost all the ICOs that have been on the market. Its purpose is for the settlement of financial transactions instead of dollars in 'a fully USD-collateralized asset with the benefit of blockchain technology and oversight from regulators' said Charles Cascarilla, CEO and co-founder of Paxos.
Translation: To make the transition easier and smoother to digitizing and cryptocurrency-izing large-scale financial transactions in a compliant way.
The Gemini coin, known as the Gemini Dollar, is a USD pegged stablecoin launched by the Winklevoss twins. Gemini is using the Ethereum blockchain as well and their trust company and coin got NYDFS approval this week. Both coins will have to do AML/KYC anti-money laundering and know your customer policies that many in the cryptocurrency world don't like as part of maintaining their compliance with NYDFS.
Should I Buy a Stablecoin?
The first inclination is if price stability is important like Tether maintaining its price at its $1 peg, then the answer is No. You don't get the benefit of investment returns AND you hold the risk that Tether may not actually have the dollars they say they do.
But what about stablecoins with non-USD pegs? All have a goal of price stability so if you think ETH will grow long-term over the USD (or your home fiat currency) then buying a coin like the PAX could make sense. Does it make more sense than buying and holding ETH directly? Probably not but they are more liquid and likely easier to exchange back into fiat money.
Stablecoins represent a stepping stone between the fiat economy and the crypto economy and for this reason alone they are valuable and need to be watched. How they manage the supply of their coin and maintain their price stability, as well as overall trust are questions you should ask yourself and the coin issuers if you are looking at a stablecoin for investment.