Blockchain and digital assets facilitate fast and secure exchange of value through a decentralized system. These have become so popular that at one point, in December 2017, one of the most prominent blockchain-based digital currencies peaked to a maximum price of over USD$19,000.The problem with this currency, however, and other similar digital assets, is their extremely volatile nature

This same currency plunged by 68.5 per cent within a span of a few weeks. While digital currencies have since gained traction and relatively more stability, traders remain uneasy about relying on such currencies. This volatility has become a main hindering factor in the wide scale adoption of digital currencies.

As a means of addressing volatility in the ecosystem, the development of stablecoins came on the scene. 

What are stablecoins?

Stablecoins aim to provide stability in the value of digital assets, while offering near-instant processing and encryption that is typical to digital currencies.

Volatility is mitigated by pegging the asset value to an external reference — an existing fiat currency or asset. For example, a stablecoin can be backed by reserves of U.S dollar, Euro, or even gold.

The idea is to ensure that their value remains stable for a considerable time thus increasing trust in their usage as a means of transaction. “Stablecoins allow an investor to diversify their portfolio with relatively less risk,” says Gregory Klumov, CEO and Founder, Stasis.

“While digital assets are often regarded as a high-volatility investment, trust and transparency are starting to bring more stability to the ecosystem,” says Andy Cheung, Head of Operations at OKEx, a digital asset exchange. “When digital asset exchanges can be counted on to operate fairly and securely, this can lead to a more stable marketplace.”

Challenges that stablecoins need to overcome

While transparency is a salient feature of the blockchain ecosystem, the challenge is in ensuring the claims of companies with regard to the type and volume of assets that back their stablecoins. Thus, there is a call for renowned stablecoins to be audited, especially since many such platforms have market capitalizations that reach billions of US dollars.

The challenge here is establishing a clear standard for doing so. “There are countries that are still trying to restrict transactions of digital assets, while others are endorsing them. Regulation is still in the works globally,” says Klumov.

Anatoly Ressin, Chief Blockchain Architect and Co-founder at blockchain analytics firm PARSIQ, shares that transparency is key to trust and effective regulation: “There needs to be a clear means to see if stability claims from respective companies are true or false. Ideally, companies need to be willing to be open to external auditors in order for true transparency to take place. If companies have nothing to hide, they should have no problem with auditors. Trust is important, and this can only be built with transparency.”

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However, most stablecoin platforms are yet to acquiesce to an external audit. “The problem is not every company can be on-boarded to have auditors,” says Klumov. “Presently, most stablecoin companies are still very small and are gathering resources of their own, before they can handle such regular auditing.”

While this does not necessarily mean anything suspicious, it does give people — especially interested investors and regulators — a reason to have doubts. To illustrate, there are recent incidents of stablecoin companies losing credibility by falsely claiming that their coins are backed by a certain fiat currency — something that has become an obstacle to winning over public trust in stablecoins.

Pushback from regulators

While stablecoins bring the promise of greater stability and reliability, there are different perspectives from regulators across the globe. 

“The challenge we are currently confronted with is the lack of clarity and the inconsistency of the regulations across different countries. Either there is no regulation at all or the regulators try to apply existing regulations that sometimes are not fit for purpose,” says Alexandre Kech, CEO of Onchain Custodian and Former Head of Securities & FX, SWIFT Asia Pacific.

“In Singapore, we’re lucky to have a proactive regulator —  when the Financial Action Task Force Recommendations came out in September, there was a rapid response in the form of an industry consultation on the measures to be adopted.

Thailand is also evolving very quickly. Other markets are trying to implement existing frameworks to digital assets, like Japan is, but this is like fitting a circle into a square. Technologically, it’s there. There is potential for development, but the current regulatory limitations that are present are a hindrance to some parties trying to enter the market right now,” he adds.

In the U.S, regulators are taking a more careful approach to digital currencies, with careful scrutiny into the unique methodologies by which each stablecoin sets value — those backed by the U.S. dollar would be treated in a different light compared to coins that maintain their prices through other means, for instance.

“Regulation is sometimes perceived as a bad thing. However, if properly done, it serves as a way to increase trust in the blockchain industry as a whole,” says Kech. “With these new rules and development of infrastructure, it will lead to a more stable platform.”

“This is a challenge for all digital asset exchanges and for the global financial economy as a whole, as innovation tends to rapidly outpace regulatory certainty,” says Cheung. “For instance, The Securities and Futures Commission from Hong Kong just released a newly drafted regulatory framework on 6 Nov, which allows the securities watchdog to issue licenses to digital asset trading platforms.”

Resolving differences with regulators

To resolve this problem, Klumov suggests that companies reach out to regulators before launching their technology: “It would definitely be better for companies to approach regulators first.”

Ressin agrees that collaboration is a necessary action companies need to take to build trust and transparency: “Stablecoins themselves already have an intrinsic need to be regulated, as they are tied to fiat currency … The regulation of these coins should be similar to the way fiat currencies are regulated and consolidated. Compliance needs to be taken into consideration, and this will allow for greater adoption of stablecoins.”

Making auditing and monitoring a reality

The first step in ensuring stablecoin companies undergo monitoring and auditing is understanding the types of audit that must take place. 

“Regarding physical auditing, the goal of the auditors is to determine that the company has enough funds to cover all the assets they have in circulation. This is not a fact that can be inferred by the blockchain itself; it’s something that has to be trusted by external auditors,” says Ressin.

Transparency is only properly achieved when these companies allow external auditors to work. Ressin adds: “We need to observe how these coins are used. Yes, it can be done to confirm that all the coins in circulation are covered and that they’re stable.

We are now asking questions on what users are using these coins for, which makes way for another form of auditing. We need a platform or form of technology to gain information from the users on what they are using their stablecoins for. This could help auditors create alerts, in the event rules are broken or attempts to compromise the network take place.”

Also Read: Bitcoin is too volatile, but stablecoins can solve this big crypto shortcoming

By fully understanding usage, stablecoin platforms can implement the right measures to curb illicit activities. Thus, stablecoin platforms need regular audits and monitoring in order to increase transparency and enhance trust from institutional and end-users.

Stablecoins are a new development, but they offer great promise in terms of ensuring digital assets can be viable instruments for transacting and investing, without the volatility that has plagued other digital asset platforms. Improved regulatory frameworks, which includes adequate monitoring, can significantly enhance trust in this technology.

Ressin is optimistic that stablecoins are the future of both digital and traditional money: “Stablecoins should be seen as the new money that should be supported by governments. Digital currencies were built to oppose traditional currency. But stablecoins share the benefits of digital assets whilst also interacting with fiat. I will wait to see stablecoins become a main mode of transaction.”

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