Digital currencies such as Bitcoin (BTC) have become synonymous with volatility. In the case of Bitcoin for instance the cryptocurrency reached a high of $19,000 last year in December but then fell to around $6,000 this year in a span of less than three months. This has raised doubts over whether it can ever serve as an everyday currency.
To solve the problem of wild swings in prices, there has been a development of new types of virtual currencies that are commonly referred to as stablecoins. Typically the value of these digital currencies is pegged to that of the US dollar. The idea is to ensure that these cryptocurrencies can be used for everyday transactions.
Trading incentives and market algorithms
Like other digital currencies stablecoins are based on the blockchain technology and make use of anonymized wallets. To ensure that the values of the stablecoins remain positively correlated to the dollar the entities behind these digital currencies employ various mechanisms including trading incentives and market algorithms.
An example of a stablecoin is Tether (USDT). This digital currency was unveiled three years ago and its owners are associated with the Bitfinex virtual currency exchange. One Tether is supposed to be equivalent to one US dollar and this has made it popular among crypto traders who use exchanges that don?t change virtual currencies into fiat currencies. This is because on such exchanges the crypto traders can move out of positions and park their money in Tether just like they would do with traditional currencies.
The problem with Tether is that no systematic mechanism is employed to make sure that one Tether is equivalent to one dollar. While the entity behind Tether claims to have reserves of euros as well as US dollars which back the digital currency the company recently parted ways with Friedman LLP, its auditors, before the completion of a full audit. This has given rise to speculation that the reserves that Tether claims to hold are not sufficient to cover for all its digital coins which are in circulation. Currently the market capitalization of Tether is $2.35 billion.
Other stablecoins which have come up in the recent past with a view to offering a better service compared to Tether include trueUSD (TUSD). The stablecoin was unveiled in January this year by a California-based startup known as TrustToken. One trueUSD is the equivalent of one US dollar and the startup holds the reserves in custodial bank accounts.
Certificates of ownership
The major difference between Tether and trueUSD is that in the latter holders of the coin are given what is deemed to be certificates of ownership of the dollar which are legally protected. Besides the legal protections, TrustToken also conducts monthly professional audits. Some of the investors in the startup include Stanford-StartX, FJ Labs and BlockTower Capital.
Another stablecoin that has come into the market in the last couple of months is dai (DAI). This stablecoin however employs an autonomous and decentralized system to remain stable. Users are required to deposit collateral in the form of Ether (ETH) and if the stablecoin fluctuates the system automatically moves to fix the imbalance.
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