Digital currencies: Stablecoins safer than cryptocurrencies

Stablecoins are less volatile as they are pegged to the underlying assets to limit price fluctuations and are more regulated as compared to other cryptocurrencies

They are usually pegged to the underlying assets to limit price fluctuations and are more regulated as compared to the other cryptocurrencies.
They are usually pegged to the underlying assets to limit price fluctuations and are more regulated as compared to the other cryptocurrencies.

By Moinak Maiti & Parthajit Kayal

SEVERAL Studies on digital currencies have been done in the last few years. When one says digital currencies, certainly cryptocurrency pops up in our mind first. However, the concept of digital currencies is not new. One can trace back its presence since the end of the 1980s in the form of DigiCash and e-gold. Recently, along with cryptocurrency, there is a significant rise in the circulation of stablecoins.

So, are they different from cryptocurrency?You know that cryptocurrencies are digital currencies that are secured by cryptography, and highly speculative. On the other hand, stablecoins are a type of cryptocurrency that is less speculative.

What is stablecoins?
Stablecoins are a special class of cryptocurrency that is less volatile. They are usually pegged to the underlying assets to limit price fluctuations and are more regulated as compared to the other cryptocurrencies. To achieve price stability, different stablecoins use diverse collateral- ised assets and methods.

Stablecoins are backed by the commodity, cryptocurrency, fiat money, or combinations of these assets.Digix Gold Tokens (DGX) is a commodity-backed stablecoin. Similarly, Tether, Binance USD, USDT, Diem, and USD coins are backed by fiat money. Then DAI is backed by cryptocurrencies.However, Seigniorage style stablecoins are less popular and are not backed by any assets. Such stablecoins utilise highly sophisticated algorithms to control money supply.

Innovation required for digital currency
The ongoing Covid-19 pandemic has brought the global economies into a very critical state. On the one end, global economies are pulled down by heavy debt burdens and on the other end, there is a need for digital transformation. In the aftermath of the Covid-19 pandemic, these two opposing forces will eventually clash. Sooner or later, it may trigger holistic innovations concerning “how one can design the best digital currency”: a digital currency that not only can effectively store the value but can also be used as the medium of exchange over time.

Value-stablecoin
MahaDAO has launched a stablecoin named “ARTH” in the third quarter of 2021. The value of ARTH is determined by the underlying purchasing power of the asset rather than its price. ARTH aims to fight the depreciation of wealth and protect you from financial crises. ARTH is not pegged to any particular asset class; rather it is pegged to a basket of uncorrelated asset classes. ARTH is backed by the basket composed of cryptocurrency (Bitcoin 5%), commodity (Gold 15%), and rest (80%) in the collection of fiat currencies (includes USD, GBP, INR, JPY, CNY, CHF, CAD, and other). ARTH uses the Global Measurement Unit (GMU) to allocate adequate weights to each asset in the basket to hedge against inflation and currency risk. ARTH creators claim it to be a new category of stablecoins as the “value-stable coins”.

Stablecoin vs regular cryptocurrencies
Due to the stable prices of stablecoins as compared to the other cryptocurrencies, it could be used as a more convenient medium for real-world transactions. Does it mean that stablecoins are risk-free? No. Stablecoins are also exposed to risk as they are backed by some asset classes such as commodities, fiat currencies, cryptocurrency and others. We know that the values of commodities, fiat currencies and cryptocurrencies do fluctuate over a period of time. The stability of the stablecoins is related to stability of underlying assets. In addition, the values of the stablecoins may also deviate due to the varying trading volumes. Hence, stablecoins investors need to do their homework before investing. The other key factor related to stablecoins investment is governance.

Decentralised Finance (DeFi) has already significantly impacted the entire traditional finance ecosystem. It will further churn the crypto space. It is true that stablecoins are less volatile than the other cryptocurrencies but they are also exposed to various risks. Thus, before investing in stablecoins, look at the underlying assets and issuing entities associated with the respective stablecoin.

Maiti is associate professor in department of finance, National Research University Higher School of Economics, and Kayal is assistant professor at Madras School of Economics

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