This year Bitcoin celebrates its 10th anniversary. With bitcoin a new technology came into existence: the blockchain. Blockchains offer a powerful mechanism to achieve secure transactions that cannot be falsified, and this mechanism doesn’t need a central authority to verify or police it. Maybe the easiest way is to compare a blockchain with a chain of domino blocks. Each block logically follows the previous block. Only the domino player that has a matching block can append it to the chain. All players keep an eye on the board and a player who tries to append a block that doesn’t fit the end of the chain will have to skip turn for cheating. In the case of blockchain a block does not include dots, but instead a list of recent transactions of cryptographic assets.
Blockchain technology has received a lot of criticism in the last few years. It is sometimes slow (especially the Bitcoin blockchain) and energy inefficient, and transfer fees are not always as low as the technology originally promised (due to its popularity). Some blockchains are used to keep track of virtual currencies, like the Bitcoin blockchain, but the values of those currencies are often not stable: the price of a Bitcoin went up from about $1000 in January 2017 to almost $20000 at the end of 2017 and fell back to around $6500 at the time of writing.
Despite the issues, in the past two years many applications which use blockchain technology have been introduced and have successfully sought funding. In 2017 blockchain technology hyped and in 2018 alone 460 projects got funded through a so-called ICO, with a total investment of 14 billion USD. ICO stands for Initial Coin Offering and can be compared with the traditional IPO (Initial Public Offering) for companies getting listed on a stock exchange. At the same time an increasing number of ICOs fails (55% of all projects in 2018) as investors become more critical on the innovations and so-called utility a project brings. You could say that the market is maturing.
Stablecoins
Price volatility, transaction delays and capacity limitations make Bitcoin, the most popular of blockchain based virtual currencies, not very suitable for day to day payments. When you put money on your Octopus, AliPay or Apple Pay account you assume the virtual money to keep the same value. You expect the same for value stored on a fitness membership card or your PayPal account. While some of these examples are less likely to go bankrupt than others, if it happens, you can forget about your money.
So-called stablecoins can address these issues. These virtual currencies are designed to have a stable value measured in fiat currencies and they usually represent a ‘real’ currency, like the USD. One of those stable coins is then designed to be worth for example one USD. By applying a few relatively easy technical fixes compared to the Bitcoin blockchain, they can also overcome the issues of transaction speeds and cost. In any case, transaction costs on blockchains (if applicable) are paid per transaction and not as a percentage of the value of the transaction, like credit cards or PayPal. This makes stablecoins a potentially strong competitor for regular payment systems.
The market for stable coins is growing rapidly. The biggest stablecoin, the Tether (which value is tethered to the USD), currently has a market cap of 1.7B USD, compared to 500M one year ago. Most discussions on stable coins concern the exchangeability of the virtual currency for their ‘real’ money equivalent. Does the company that gave out the virtual currency in exchange for real money still have that money to buy back the virtual currency? In a way the companies behind stablecoins operate as banks or even as central banks, printing their own money and managing demand and supply of money.
Stablecoins are legally and practically not (yet) the same as stored value systems like Octopus or AliPay. The value of the stablecoin is often not completely guaranteed. The dollars on your Octopus card may be considered 100% the same as cash dollars, even though the shop where you pay with those systems will pay a small transaction fee and/or membership fee, where most stable coins do not. The blockchain industry is rapidly developing better methods to make its systems transparent and to secure long-term reliability of these systems and the organizations behind it. Currently stablecoins are mainly being used within the blockchain industry, but with user experience improving, the decentralized almost-free technology is expected to make a dent in the current market of mainstream payment systems in the near future.
(This article first appeared in the Dutch Chamber Magazine, publication of the Dutch Chamber in Hong Kong)