VeriNumus: The Future of Stablecoins
Introduction
The downfall of Terra Luna (LUNA) and TerraUSD (UST) in May 2022 reverberated throughout the cryptocurrency market, revealing the weaknesses of algorithmic stablecoins and the systemic risks involved. As LUNA's value plummeted and UST lost its peg, investors suffered substantial losses, leading to a critical reassessment of the mechanisms that support stablecoins. In this context, Hong Kong has emerged as a vibrant hub for cryptocurrency innovation, offering a unique blend of regulatory clarity and technological advancement, fostering a conductive atmosphere for the development of stablecoins.
The Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) are actively crafting regulations that bolster user confidence. As reported by the Hong Kong Stock Exchange, the virtual asset market in Hong Kong has experienced significant growth over the past few years, increasing from a market capitalisation of US$500 billion in 2013 to more than US$2 trillion as of May 2024, underscoring the increasing importance and potential of stablecoins within the cryptocurrency ecosystem in Hong Kong.
What are stablecoins and their types
Stablecoins are cryptocurrencies designed to maintain a value that is pegged to another currency, commodity, or financial instrument. Their primary goal is to offer a stable alternative to the significant volatility, which can reach up to 80% or more, typically seen with popular cryptocurrencies like Bitcoin. There are four common types of stablecoins, which includes:
| Types | Overview | Example |
|---|---|---|
| 1. Fiat-Collateralised Stablecoins | Backed by reserves of government-issued currencies like the US dollar or Euro, each stablecoin is supported by an equivalent or greater amount of fiat held in reserve, ensuring a 1:1 peg. These reserves are usually managed by independent custodians and undergo regular audits to enhance transparency and trust. | Tether (USDT) and TrueUSD (TUSD) |
| 2. Commodity-Backed Stablecoins | A sub-category of fiat-collateralised coins, these stablecoins are pegged to the market value of physical assets like gold, silver, or oil. They maintain reserves of these commodities, usually held off-chain by trusted custodians, ensuring their value aligns closely with the market rate of the underlying assets. | Tether Gold (XAUT) and PAX Gold (PAXG) |
| 3. Crypto-Collateralised Stablecoins | Backed by reserves of other volatile cryptocurrencies, these stablecoins are typically over-collateralised, meaning the collateral's value exceeds that of the issued stablecoins. They may also be supported by fiat-collateralised stablecoins to help maintain price stability. | DAI, sUSD |
| 4. Algorithmic Stablecoins | Maintain value stability by controlling supply through algorithms and smart contracts, rather than relying on reserve assets. Unlike asset-backed tokens, they are not tied to fiat or commodities. Instead, they adjust the circulating supply based on market demand: creating more tokens when prices rise and reducing tokens when prices fall. This dynamic incentivises arbitrage traders to buy or sell, helping to restore the peg to the target value. | DAI, Terra (LUNA), Ampleforth (AMPL) |
Importance and benefits of stablecoins
Stablecoins have emerged as a fundamental element of the cryptocurrency market, providing a user-friendly means for global transactions, even for individuals who may not be experienced in crypto. Common examples of stablecoins usage include daily transactions, remittances and trading. More importantly, they play a crucial role in the adoption of decentralised finance (DeFi) by serving as a reliable medium of exchange on DeFi platforms. This stability allows users to trade, lend, and borrow with confidence, fostering trust and encouraging broader participation in the cryptocurrency ecosystem.
1. Stability protection
Stablecoins maintain a consistent value, shielding users from the significant price fluctuations often experienced with major cryptocurrencies like Bitcoin.
2. Facilitation of DeFi development
Many decentralised finance (DeFi) platforms depend on stablecoins, providing attractive opportunities for lending, borrowing, and yield farming that go beyond traditional banking solutions.
3. Security and transparency
By utilising blockchain technology, stablecoins ensure transparent transactions and strong security features, setting them apart from centralised fiat currencies.
4. Financial inclusion
Stablecoins are particularly beneficial in areas with limited banking access or unstable local currencies, offering a dependable alternative for preserving value.
5. Greater accessibility
Stablecoins can be more easily accessed and used by individuals without extensive knowledge of cryptocurrency, as they offer a more straightforward way to engage with digital assets.
The role of HKMA's Fintech Supervisory Sandbox in the emergence of stablecoins
The Fintech Supervisory Sandbox (FSS) established by the HKMA plays a crucial role in fostering innovation within the financial sector. Since its launch in 2016, the FSS has undergone several enhancements to better support fintech development. The recent FSS 3.1 Pilot provides funding for innovative solutions that meet specific criteria, including registration in Hong Kong, involvement in substantive fintech activities, and collaboration with a Hong Kong bank.
This sandbox environment facilitates local fintech firms in testing and refining their innovative solutions, significantly contributing to the development of stablecoins. As demand for stability and trust in the cryptocurrency market increases, stablecoins emerge as a viable alternative to more volatile assets like Bitcoin, which can experience significant price fluctuations. By being pegged to stable assets such as fiat currencies or commodities, stablecoins provide a reliable store of value.
Moreover, the HKMA's sandbox promotes numerous opportunities for stablecoins within the Hong Kong landscape, encouraging collaboration between fintech firms and traditional financial institutions. This synergy not only supports the growth of stablecoins but also enhances the overall financial ecosystem, positioning Hong Kong as an emerging leader in the evolving landscape of digital finance.
Conclusion
To summarise, stablecoins represent a critical advancement in the cryptocurrency landscape, serving as a secure option for investors and laying the groundwork for the future of digital finance. As regulatory frameworks solidify and technological advancements continue, stablecoins are expected to play an increasingly important role in the global economy, fostering a more stable and inclusive financial future.