Stablecoins are a welcome attempt to bring stability to the digital assets market. Much like a country pegging its volatile currency to a more stable country’s currency in an effort to make its economy more predictable and attractive to investors, digital assets issued by companies like Tether and Haaven are anchoring to the U.S. dollar, gold reserves or even the algorithm behind the digital asset itself.

When every day seems to bring a new swing in the price of Bitcoin and other volatile digital assets, any effort to bring more calm to the market is appreciated. Yet, history demonstrates that the stability promised by the name ‘stablecoins’ is impossible to guarantee.

Pegging problems

By definition, pegging creates an artificial economic environment that cannot be sustained in the wider unconstrained market over a long period. Past examples of fiat currency pegging prove that while it may act as a short-term solution, the inevitable unpegging creates serious instability.

As a major oil producer, Nigeria decided to peg its currency, the naira, to the U.S. dollar in order to maintain a consistent export value. When oil prices began to decline in the mid-2010s, the naira also should have dropped except that the Nigerian government spent nearly 20 percent of the country’s foreign reserves to maintain the peg. With the currency trading at half its value on the black market, Nigeria soon was forced to unpeg from the dollar. The result was a 30 percent collapse in the naira’s value and skyrocketing inflation.

An even more significant example happened in Thailand in the 1990s. With the Thai baht pegged to the U.S. dollar, the country was one of the much-lauded “tiger cub” economies of Southeast Asia. But when economic growth began to slow, investors started betting that the baht would lose value. As in Nigeria, the Thai government spent billions of dollars defending the peg before eventually abandoning it in 1997. The resulting depreciation of the baht had a domino effect in the entire region and sparked the infamous Asian financial crisis of the late ‘90s.

The misbehaving market

The problem with pegging is that the theory relies on the market behaving in specific ways. But you can’t tell the market what to do. Either people find loopholes to exploit, create a black market that better reflects real value or simply don’t behave as the efficient-market hypothesis suggests they should.

Just look at the currency used in most pegging situations, the U.S. dollar. As currencies backed by more stable governments and central banks, than the governing bodies and institutions in the U.S., the Swiss franc and Singapore dollar perhaps represent a more stable pegging option. Yet the dollar is the default choice because people trust it. This is not logical, but rather, because of its legacy and emotional appeal. People outside the US are used to dealing with the dollar and are, therefore, more comfortable with it than any other currency in the world.

The lesson here is that it’s often more valuable to look at what people are actually doing and not what they should be doing. To bring it back to stablecoins, Tether is the runaway leader in the market despite the questions over whether it has enough reserves to support its U.S. dollar peg. But that doesn’t seem to matter because enough people believe in it. If the tether (USDT) loses value and some holders panic sell, there are enough potential buyers who trust that the company is committed to returning the stablecoin to its pegged price.

Factors influencing stability

The digital assets market is still emerging and its future is hard to predict. White papers and valuation hype will only get you so far. Other factors — those that rely on more tangible outcomes — may be more effective tools for assessing stability over the long-term.

Like with the dollar, looking at the perceived trust in an asset is one way of assessing its staying power. Strong communities are more likely to retain their faith during good and bad times, which may act as a guard against volatility.

Another way is to look for digital assets with a clear use case, whether in cross-border payments, consumer payments or as a consistent store of value.  Having a use case can only help to build more trust and broaden the community behind it.

Peg or no peg, these factors are more likely to build a truly stable coin.

About the Author

Thomas Lee is a Managing Partner and the Head of Research at Fundstrat Global Advisors. He is an accomplished Wall Street strategist with over 25 years of experience in equity research, and has been top ranked by Institutional Investor every year since 1998. Prior to co-founding Fundstrat, he served most recently as J.P. Morgan’s Chief Equity Strategist from 2007 to 2014, and previously as Managing Director at Salomon Smith Barney. His areas of expertise include market strategy, small/mid-cap strategy and telecom services.

The post Stablecoins: A Lesson in Market Predictions appeared first on Ripple.

Similar to Notcoin - TapSwap on Solana Airdrops In 2024

origin »

170 +