This is a guest post by Deb Shaw of MarketsNow.com.
Should we expect to see reliable commodity backed cryptocurrencies emerge in the future? The reality is that such cryptocurrencies would be backed by a range of different financial assets (stocks, bonds, precious metals etc.) hosted in reputable jurisdictions with fully audited financial statements. However, there are obstacles to overcome, most pertinently trust and transparency.
Although cryptocurrencies have made substantial gains in the last few years (outperforming traditional currencies) they are still a poor store of value and are currently impractical as an alternative to money. Subsequently, version 2.0 of pegged cryptocurrencies is still a work in progress. Let’s take a look at some of the challenges faced by those building commodity backed cryptocurrencies.
Cryptocurrencies are Volatile
Many cryptocurrencies have risen in value over recent years but very few have the qualities to serve as a monetary yardstick. Generally they are volatile as an asset class, difficult to store safely, and its underlying technology may become obsolete. As new cryptocurrencies are emerging all the time with advances in speed and scalability, any one cryptocurrency is always at threat of a decrease in demand.
On the other hand, commodities like gold are seen as a more secure store of value, with analysis indicating it is more closely tied to the fortunes of traditional currency.
As an asset class cryptocurrencies are more like technology stocks: capable of quick appreciation but with inherent risks which can lead to rapid and significant devaluation. This may make them attractive to certain investors but must not be mistaken for being a stable store of value.
The current stable of cryptocurrencies pegged to the US Dollar has generally failed to gain traction and/or suffer from low credibility. Tether is a cryptocurrency supposedly pegged to the US Dollar and it’s one of the largest coins by assets in the market today. The tethers (also known at USDTs) that are issued have a value pegged directly to the US Dollar. To do this, Tether commits to having a US Dollar reserve equivalent to all the value of all USDTs.
There are doubts about its US Dollar asset base. In January, $850 million worth of Tethers were created which naturally drew questions about the underlying US Dollars that supposedly backed them. Promises of Tether being backed up safely seem vague and if there was a large cash-out of Tether there may not be the dollars to back it up. Currently, a reliable audit trail does not exist. The accounting firm Friedman LLP was working on an audit but that relationship ended for reasons unknown. The bottom line is that with $2 billion in Tethers in the market place there is no concrete proof of a corresponding $2 billion.
Other competitors have also failed to gain traction: BitUSD and NuBits being two examples. After a high of $2.5 million, today NuBits’ market value is around $135,000 and daily trading volumes are only $2000. Its rate-pegging intervention mechanism failed and it had a devaluation crisis, with the price falling to 20 cents. Ultimately, its reputation never recovered from this. BitUSD is built on the blockchain cryptocurrency BitShareX. It peaked at a market cap of $1 million but has fallen to less than $110,000. This happened even though it performed reasonably well by maintaining a consistent value around $1. This again raises questions over credibility and trust.
Although these (and other commodity pegged cryptocurrencies) had different pegging mechanisms that were generally complicated and not always transparent, there are two negative points they all shared: First, the rate-pegging mechanism relied on non-programmed policies which were enacted with a central authority; and second, none of them used the standard currency pegging method of holding reserves in the currency they were pegged to.
Version 2.0 of Pegged Cryptocurrencies
The advantages of a currency backed cryptocurrency are considerable, which means it is likely to be a matter of time before we see a reliable commodity backed cryptocurrency. The advantages over a conventional bank are many: you can transact US Dollars without intermediaries; cold store value using private keys; move currency in and out of exchanges easily and avoid the necessity of opening a bank account for currency. This gives commodity backed cryptocurrency the same advantages of non-commodity pegged cryptocurrency (avoiding fees and remitting payments globally), but without the need to convert prices or go through the process and fees of conversion.
The mechanics of establishing a commodity backed cryptocurrency are fairly simple: the main issue that creators will face is generating a high degree of trust. Eventually we will see cryptocurrencies backed by financial assets in reputable ‘crypto friendly’ jurisdictions (e.g. Switzerland) with audited financial statements. Without this level of trust and transparency, commodity backed cryptocurrencies are likely to suffer from limited traction.
If you’re interested in commodity analysis, you can read more at MarketsNow.