Stablecoins can eliminate crypto-currency volatility

Read time 5min 50sec

Local crypto-currency market players believe a rand-backed “stablecoin” may open an avenue of innovation in the South African payments industry.

This as the market grapples with the volatility in crypto-currencies like Bitcoin. From its peak at the end of 2017 of close to $20 000, Bitcoin plummeted to $3 200 in December 2018 but has since increased to around $8 000 recently.

According to Seshree Govender, a senior associate at Webber Wentzel, stablecoins are crypto assets which are backed by the value of a “stable” asset, or a basket of assets.

She points out that as the value of the backing asset will not necessarily be subject to the same fluctuating circumstances applicable to the value of crypto-currencies, pegging a stablecoin to an asset can stabilise the value and inherent purchasing power of the stablecoin crypto-currency so that it may be used as a viable and economic medium of exchange as opposed to a speculative asset.

“While stablecoins can be stabilised by various types of backing assets, the most widely recognised is fiat currency,” says Govender.

“Such stablecoins are backed on a 1:1 ratio with a particular fiat currency value (eg the rand). Fiat-backed stablecoins are, thus, able to operate as a form of digital cash that is issued and circulated through a decentralised economy and payment system.”

Financial inclusion

She believes that enabling the issuing and circulation of a rand-backed stablecoin may open an interesting avenue of innovation in the South African payments industry by providing a decentralised means of issuing monetary value, and clearing and settlement payments using such stablecoins.

“The introduction of a rand-backed stablecoin may be able to achieve financial inclusion in the payments industry through its nature as a decentralised value and payment system. However, it will only be able to achieve such innovation if such stablecoins can be regarded as legal tender,” says Govender.

She adds that as SA is transitioning from a traditional and financially exclusive payment regulatory regime to a more innovative and inclusive regime, the introduction of a rand-backed stablecoin, which is not regarded as legal tender as yet, may bring with it systemic risk and potential detriment to the payments industry if done without sufficient regulatory consideration and supervision.

“The recent auditing concerns surrounding the US-dollar-backed ‘Tether’ stablecoin and its fiat currency reserves illustrate the potential risk that can arise in the instance where the custodian of the fiat currency reserves and issuer of the fiat-backed stablecoin are not institutions subject to regulatory oversight.”

Eliminating volatility

Marius Reitz, head of Luno Africa, notes stablecoins are crypto-currencies that are, in theory, meant to eliminate the volatility that the more traditional crypto-currencies like Bitcoin are usually associated with.

“Stablecoins essentially provide a ‘bridge’ to fully decentralised crypto-currencies like Bitcoin. Because they are easier to trust and understand, they are effectively a way for people to slowly learn about crypto until they are ready to go into the newer types like Bitcoin,” Reitz says.

However, he points out it’s difficult to speculate whether stablecoins will have a place in the crypto sphere in years to come, once mass adoption and wider education surrounding crypto-currencies becomes more prevalent.

“Where they are still somewhat challenged is that stablecoins have to go through the same distribution channels as Bitcoin and Ethereum right now – typically exchanges and wallets – which is not necessarily a bad thing, but will make adoption slower.”

Reitz believes there will continue to be regulatory challenges, especially with capital controls which are a reality of life in most developing economies.

“To enable a broad set of use cases, stablecoins will still require traditional fiat onramps, or local liquidity of fiat currency being traded to them. While they might be easier to trust and understand than crypto-currencies like Bitcoin, a lot of education still needs to be done at both a grassroots consumer and higher institutional level.”

Medium of exchange

Farzam Ehsani, VALR CEO, is of the view that stablecoins are an effort to make crypto-currencies more useful as a medium of exchange, but this is often achieved by backing them by another asset such as the US dollar, which effectively makes them vouchers for the underlying asset.

“The volatility of decentralised crypto-currencies will continue for some time but will reduce as adoption increases,” says Ehsani.

Nonetheless, he notes stablecoins often imply that one needs to trust an institution that is holding whatever the stablecoin is backed by.

“One of the strengths of decentralised crypto-currencies is that you don’t need to necessarily trust any institution. This is a big disadvantage of most stablecoins.”

Meanwhile, Petri Redelinghuys, founder of Herenya Capital Advisors, says: “I don’t think stablecoins really embody the vision of cryptos. However, I do think they are a way for the traditional banking system to integrate blockchain technology into their existing ecosystems.

“I think banks realise cryptos are a real threat to them and the entire fractional reserve banking system, and they are trying everything they can to lock cryptos into their own ecosystems so that they do no lose control of ‘money’.”

For Richard de Sousa, senior partner at AltCoinTrader, the volatility in crypto-currency is not something that needs to be solved.

“It is part of the charm and what crypto-currencies are about, but more importantly it is part of the fact that crypto-currencies are very new to the financial industry. It is a new financial democracy that needs to find its place in the crypto sphere in the financial system. And while it finds its place, it will be volatile until it eases out.”

De Sousa notes that the major disadvantage of stablecoins is that anyone creating a stablecoin, unless they have a specific purpose for creating it, has misunderstood what was the real intention behind creating crypto-currencies are.

“They are looking for something to create that is not necessary if it defies the purpose of it being decentralised and immutable. Our current banking systems, not only in South Africa but the entire world, are already using their fiat currencies as 'digital' or online currencies.

“It is estimated that South Africa has less than 10% in cash, 90% is in digital currency. As it is centralised it means that it can be changed and manipulated at the discretion of governments creating it.”

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