Explainer: 'Stablecoins' in the spotlight as Facebook unveils Libra cryptocurrency

LONDON (Reuters) – Is bitcoin’s crown slipping?

The original cryptocurrency accounts for over half of the $285 billion global coin trading market. But that dominance is under threat, with a host of alternative digital coins emerging as developers race to build cryptocurrencies able to enter mainstream commerce and finance.

As these “altcoins” gain prominence, Reuters is publishing a series of stories that looks at the major alternatives to bitcoin as they muscle their way onto the radar of developers, investors and regulators.

Facebook Inc revealed plans on Tuesday to launch a cryptocurrency called Libra, the latest development in its effort to expand beyond social networking and move into e-commerce and global payments.

Like a variety of altcoins known as “stablecoins,” Libra will be backed by a reserve of real-world assets, including bank deposits and short-term government securities. This should make it more stable than other cryptocurrencies.

Here are three key questions about stablecoins.

WHAT’S THE BIG IDEA?

Stablecoins are designed to overcome the wild price swings that have rendered bitcoin and other cryptocurrencies impractical both for commerce and payments and as a store of value.

In theory, stablecoins should then be more useful for paying for goods and services or transferring money across borders. Most are backed on a one-to-one basis by mainstream assets like the U.S. dollar, while others are collateralized by baskets of cryptocurrencies. Some use algorithms to maintain stable values.

Proponents say stablecoins could help cryptocurrencies gain mainstream appeal.

By overcoming bitcoin’s perennial headache of high volatility, the argument goes, stablecoins could pave the way for the adoption of a wider suite of blockchain- and cryptocurrency-based financial products that aren’t currently practical.

“People talk about doing crop insurance on the blockchain – but they can’t do that with an asset that moves 10%, day by day,” said Peter Smith, CEO of Blockchain, a London-based cryptocurrency exchange and one of the original providers of digital wallets. “It just doesn’t work.”

WHO ARE THE MAJOR INCUMBENTS?

Tether, the highest-profile stablecoin, is the ninth-biggest cryptocurrency by market capitalization, with coins worth around $3.5 billion in existence. That’s a fraction of bitcoin’s $163 billion market cap.

Tether has faced by questions over whether it holds the U.S. dollars to back the tokens in circulation. Tether has said it has sufficient reserves, though it added in March that its tokens were backed by both currency and “cash equivalents”.

USD Coin, run by the Goldman Sachs-backed startup Circle and the San Francisco-based Coinbase exchange, has a circulation worth around $343 million. Others, including the Paxos Standard and the Gemini Dollar, are much smaller.

But in contrast to Facebook’s cryptocurrency, these stablecoins are all issued by “crypto-native” firms whose roots are in the nascent sector. They have therefore faced an uphill struggle for wider acceptance in the real economy.

ARE STABLECOINS USED DIFFERENTLY TO BITCOIN?

It’s hard to gauge exactly how cryptocurrencies are used, given their near-anonymity. But researchers say stablecoins, like bitcoin, are seldom used for payments, even if their lack of volatility should make them more useful.

Other cryptocurrency traders and exchange operators said investors use stablecoins to hedge against spikes in bitcoin’s price, and as a means to trade cryptocurrencies without using dollars.

Combined trading volumes at major exchanges of five of the biggest stablecoins, including Tether and USD Coin, have spiked in recent months. According to data from U.S. researcher Coin Metrics, volumes rose to $74 billion in May, a more than four fold increase from December.

“If they feel bitcoin is going to go up or down, they prefer to cash out to a stablecoin – it allows them to trade quicker, and get back into the market,” said Thomas Puech of Enigma Securities, a London-based cryptocurrency exchange.

Other traders see in stablecoins opportunities for arbitrage between the myriad exchanges across the globe, said Michel Rauchs, cryptocurrency and blockchain lead at the University of Cambridge’s Centre for Alternative Finance.

“Now you have a way to essentially transfer your dollars in and out of exchanges pretty much instantly, which of course makes it a lot easier to do arbitrage,” he said.

Tether is also popular among investors in mainland China looking to get around tight capital controls and move money offshore as the Chinese economy slows, said Bill Xing of New York-based cryptocurrency index firm Panda Analytics.