A new form of cryptocurrency promises to defy financial gravity

Can stablecoins live up to their name?

To get an idea of just how volatile cryptocurrencies are, compare them with the stockmarket. Bitcoin, the biggest one, moves as much against the dollar in a single day as the s&p 500 does in 23. For speculators, this is a feature. For anyone who wants to use these digital monies for payments, savings or lending, it is a bug. In other words, volatility is a big obstacle to cryptocurrencies becoming much more widely used.

Stablecoins are an attempt to overcome this hurdle: they are cryptocurrencies designed to hold a steady price. Their number has multiplied recently. At least 20 are now traded on crypto-exchanges and many more are in development. Despite their growing number, they still account for just 1.5% of the value of cryptocurrencies in circulation. But they are involved in a large share of all trading.

Investors use them to park assets when they do not want to hold volatile cryptocurrencies but also do not want to move back into “fiat” (government-issued money). Big venture-capital firms, such as Google Ventures and Andreessen Horowitz, have given their approval, investing more than $350m in stablecoin projects.

Most stablecoins are backed by real-world assets such as fiat or gold. Some are collateralised by a basket of other cryptocurrencies. Others have no collateral at all, but are controlled by an algorithm that increases or decreases supply to keep their prices stable.

Whatever their inner workings, the big question is whether stablecoins can live up to their name. It has become more pressing in recent days. On October 15th Tether, which is backed by dollars and is the biggest of the lot, with a typical daily trading volume of around $2.5bn, suffered the latest in a series of speculative scares. That pushed its value down to an 18-month low. It has since recovered most of its losses, but the incident was a reminder of worries about Tether’s solidity. The firm that backs it has not yet presented incontestable proof of the funds it claims to hold to secure the coin’s dollar peg.

Rivals are seizing on Tether’s wobbles as an opportunity to set themselves apart. Many new issuers now adhere voluntarily to anti-money-laundering and know-your-customer checks by national regulators. Trueusd, another dollar-backed stablecoin, submits to regular audits and holds collateral funds in an external trust. Eidoo, a company offering a gold-backed stablecoin, invites customers to keep an eye on its reserves of the precious metal through a video link to the vault where they are stored.

Still, experts outside the crypto-sphere are not convinced that stablecoins are here to stay. That is not solely because their pegs may break, as can happen with real-world currencies and assets. For Barry Eichengreen of the University of California, Berkeley, for instance, some stablecoins have characteristics that are “attractive to money-launderers and tax-evaders”. Among other things, they could be used to evade the taxes that become due in many jurisdictions when cryptocurrencies are exchanged for fiat. Regulators had better keep their eyes wide open.