Usually, no one bats an eye when a cryptocurrency’s price drops 30 percent over the course of a week. This is the Wild West, after all.
But when it happened to DAI this month, heads turned, primarily because the token was designed specifically to hold its peg with the U.S. dollar.
One of a growing number of crypto tokens referred to as “stablecoins,” these cryptocurrencies are engineered to adjust their supply as the market shifts, issuing when prices rise and retracting when they drop, in an effort to keep their prices steady.
Called the “holy grail” of cryptocurrency, stablecoins have been heralded as a way to strengthen the commercial case for blockchains, since many businesses shy away from the volatility associated with the sector.
Case in point: an increasing number of decentralized apps (Dapps) rely on ether, and on internal crypto tokens dependent on ether, as a way to distribute value. As a result, unpredictable market shifts in the price of ether could cause chaos in the system.
Dapp users would be less likely to spend their tokens if they believed the value might double overnight; conversely, should potential users suspect the value of the Dapp tokens will plummet, that could discourage them from participating at all.
For this reason, Rune Christensen, the founder of MakerDAO, the company behind the DAI stablecoin, which was launched in December, told CoinDesk:
“[Stablecoins] are the first step before you actually see anything else interesting happening. I would argue that the reason why the blockchain world is so vapor-wary … is basically because you just cannot do business in an unstable environment.”
And in this pursuit of stability, interest in refining the stablecoin technology seems to be on the rise moving into 2018.
Not only did an all-star group of investors, including Andreessen Horowitz and Pantera Capital, back a stablecoin project called basecoin in October, but CoinDesk has heard more such projects are on their way.
Plus the popularity in China of BitCNY – which is pegged to the Chinese renminbi and has entirely replaced renminbi trading pairs due to strict regulation of fiat/crypto trading in the country – led Christensen to describe stablecoins as “pretty much the best example of blockchain done right at the moment.”
Yet, according to critics, DAI’s brief spell of trading for around 72 cents only foreshadows impending doom that the market has seen several times already with stablecoins.
An inauspicious start
While stablecoins see trading in the tens of billions of dollars per day, many crypto enthusiasts have called the technology the “single point of failure” for the entire crypto industry.
Preston Byrne, an independent consultant and the former chief operating officer and legal counsel of Monax Industries, has even gone so far as to call stablecoins the “single dumbest creature in the entire universe,” alluding to the Bugblatter Beast from “The Hitchhiker’s Guide to the Galaxy.”
And such criticisms are not entirely unfounded.
Perhaps the most well known of the stablecoins is USDT (U.S. dollar tether), which acts as a stand-in for the dollar on some of the world’s largest cryptocurrency exchanges. And while that function seems to validate its existence, the company behind the coin, Tether Limited, has seen its fair share of controversy.
For instance, last year, Tether Limited was allegedly hacked for $30 million in USDT.
And in a wave of recent accusations, the relationship between Tether Limited and the Bitfinex exchange has been harshly criticized.
While Tether’s U.S. dollar-pegged crypto has been around since July 2014, formerly under the name Realcoin, Bitfinex, under immense pressure after losing banking relationships and the ability to send fiat wire transfers, ushered in broader use of the Tether stablecoin in 2015. USDT is widely seen as a substitute for traditional banking services, allowing users to withdraw and deposit dollar amounts quickly.
But since then, there has been much scrutiny of the close ties between Bitfinex and Tether (the companies have common ownership and management) and accusations of mismanagement. Some, most prominently the pseudonymous blogger “Bitfinexed,” have gone as far as to claim that USDT has no material basis, and is instead steadily pumped into the marketplace to move the price of bitcoin upward.
Speaking to CoinDesk, a Tether representative said, “The same principals have been involved in both Bitfinex and Tether since the beginning – that has never been a secret. Suggestions that USDT has no material basis have no merit. Tether is fully backed dollar for dollar.”
Similar issues also haunted NuShares after its distribution of the NuBits stablecoin in 2016.
Even though the project set out to maintain the stability of the currency through economic incentives, following a wave of hacks and alleged manipulation of the peg by stakeholders, the stablecoin traded for as low as 10 cents the same year.
At the time, NuBits core developer Jordan Lee blamed the blunders on “suicidal tendencies” in the community.
Small numbers, big mistakes?
Similarly cited by critics of the concept is the suspension of trading of BitUSD, what is perhaps the first stablecoin, on the BitShares exchange in 2014 after a security bug was found in the code.
Yet remarkably, in the four years since that happened, BitUSD has mostly maintained its parity – although “mostly” is still problematic.
Last week, BitUSD hit $1.10 per coin, according to CoinMarketCap. Small deviations of this type could incentivize traders to take advantage.
Or as Christensen said, “If you’re buying DAI at slightly lower than one dollar and selling DAI at slightly above one dollar, in a dollar-denominated market, it’s just like a really easy way to essentially arbitrage the inefficiencies of the market.”
However, Christensen said, the tiny price fluctuations these stablecoins appear to have on CoinMarketCap don’t translate to the price of the currencies on individual exchanges.
Rather, due to how CoinMarketCap calculates the average price of cryptocurrencies, “there’s always going to be this volatility effect apparent on the price charts,” he said.
To him, it doesn’t make sense to claim the technology isn’t working just because it’s seen a few pitfalls, since there are stablecoins operating successfully in the market today.
“BitUSD is one of the first really good examples of a smart contract or blockchain 2.0 technology actually working really well and in particular, providing real world utility in a way that almost no other blockchain stuff has done before,” Christensen said.
Still, according to Christensen, discrepancies between CoinMarketCap and the exchanges where DAI is traded weren’t at fault for that coin’s drop last week.
Rather, those price fluctuations, Christensen speculated, were due to a market-making trading bot gone awol on the Chinese exchange, Bibox. When that market maker went down, another high-frequency trading bot started skewing the price, he suggested. Underscoring his point, DAI traded for $1.10 on another exchange, Gatecoin, the same day it went for 72 cents on Bibox.
And this volatility spooks crypto enthusiasts, who are worried about a potential “black swan event” or a “death spiral.” In such a scenario, the asset a stablecoin is backed by suddenly falls, and in turn pushes the stablecoin down and with it the whole multi-billion dollar crypto market.
But as these technologies advance, stablecoin creators are building in precautions.
For instance, the team behind MakerDAO said it has mitigated the possibility of a death spiral by backing DAI with a diverse array of supporting assets, in an upcoming version of the DAI token to be released this summer.
“So [a black swan event] is highly theoretical and should only happen in conditions of extreme negligence. And with proper diversification it should, in theory, be possible to prevent with 99.9 percent certainty,” Christensen told CoinDesk.
And all these instances just seem to display that the technology, and the surrounding crypto infrastructure, is still so new that hiccups should be expected.
“Really early-stage markets for a new stablecoin are definitely some of the weirdest market conditions,” Christensen said.
He compared DAI’s dip to BitUSD’s price drop following its launch, explaining that before these stablecoins become widely traded on a particular market, they’re vulnerable to bots and bugs.
As Andy Milenius, a developer at MakerDAO, told CoinDesk:
“When DAI volume is the tens of millions and then it demonstrates volatility, we will have something interesting to talk about.”