Tyler Winklevoss, left, and Cameron Winklevoss, co-founders of Gemini Trust Co.


Photo:

Callaghan O’Hare/Bloomberg News

Cryptocurrencies have yet to reach mainstream adoption, but one part of the market that has seen substantial growth is stablecoins.

Stablecoins have become popular in the digital-currency industry because they don’t have the wild volatility associated with other crypto assets such as bitcoin. Stablecoin prices are often pegged at a one-to-one ratio to a stable asset such as the U.S. dollar, which is held in reserve as collateral. That means a buyer who pays $1 for a stablecoin usually can redeem it for $1 later on.

Global trading volume in stablecoins surged in 2018, rising to around $82 billion from $12.5 billion in 2017, according to research firm Chainalysis’s tracking of four major stablecoins. More recently, stablecoin trading volume more than quadrupled in the 12 months through April 2019, according to research firm The Block.

Because they are designed to maintain a steady price, stablecoins have become a major source of liquidity in cryptocurrency markets. They are used by traders and investors to buy other cryptocurrencies on exchanges that don’t accept fiat currencies, and as a place to park funds when other crypto assets are experiencing big price swings.

Eventually, enthusiasts say, stablecoins could be used for financial transactions such as loans, remittances, wire transfers and payments, delivering on the crypto industry’s longstanding promise to make such transactions cheaper, faster and easier.

Still, the use of stablecoins for real-world purposes other than trading remains far off, some analysts and investors say, due to a lack of financial networks that can accept and use cryptocurrencies.

Filling a need

For traders and investors, however, stablecoins address a problem that plagues many popular crypto exchanges around the world—the exchanges don’t have relationships with banks, meaning investors can’t use dollars, euros or other government-backed currency to buy the cryptocurrencies they want to trade. (Many banks avoid crypto exchanges, wary of the money-laundering risks associated with digital currencies.)

So to purchase cryptocurrencies, traders often buy stablecoins with dollars on an exchange that has a relationship with a bank, and then transfer the stablecoins to the exchange where they want to trade.

Similarly, traders often can’t sell cryptocurrencies for dollars, so they sell into stablecoins instead. As a result, many exchanges use stablecoins as trading pairs, not dollars.

“From a trader’s point of view [stablecoins] are quite crucial to liquidity,” says Ciaran Murray, a London-based cryptocurrency trader.

While dozens of stablecoins have been launched or announced, the most popular one by far is Tether, which accounts for 94% of total stablecoin transaction volume, according to Chainalysis.

Tether, however, hasn’t been without controversy.

In April, the New York Attorney General’s office accused Hong Kong-based iFiniex Inc.—the company behind Tether and the cryptocurrency exchange Bitfinex—of raiding Tether’s dollar reserves to cover up $850 million in customer funds that went missing from the exchange. Although Bitfinex has said the attorney general’s filings were riddled with false accusations and that Tether is financially strong, some question whether there are enough dollars in reserve to back up the coins in circulation.

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Stable Mates

Trading in stablecoins, a relatively new form of cryptocurrency, one that is often pegged to a stable asset such as the U.S. dollar, has surged in recent months.

Weekly total transaction volume

$4.0 billion

3.0

Tether

2.0

1.0

USD Coin

Paxos

Gemini

0

2017

’18

’19

Source: Chainalysis

Despite those concerns, Tether remains popular because of the liquidity it provides, Mr. Murray says.

Two other stablecoins—one from Paxos Trust Co. and the other from Gemini Trust Co., the company founded by twin-brother entrepreneurs Cameron and Tyler Winklevoss—were launched last year with approval from New York regulators, which was a first.

That means the dollars used to purchase these tokens—the Paxos Standard and Gemini Dollar—are held in trusts or banks, audited regularly and regulated by the New York Department of Financial Services, adding an extra layer of protection, according to the companies.

Two other stablecoins, USD Coin and TrueUSD, aren’t regulated but the companies behind them say their approaches are designed to minimize risk. USD Coin is managed by a consortium of companies, including Coinbase Inc. and Circle Internet Financial Ltd., so that no one company controls the digital currency’s fate, according to Emre Tekisalp, the USD Coin project lead at Coinbase. TrueUSD, created by TrustToken, holds its collateral in multiple third-party trust companies to reduce risk for investors, says Jai An, TrustToken’s CEO.

New use: lending

There also are decentralized stablecoins, which aren’t controlled by any company but are governed by token holders, similar to how open-source software is managed.

One such stablecoin, Maker DAO’s DAI token, is used for something that most others aren’t: lending. Users place collateral into the system—currently only the cryptocurrency Ether is accepted as collateral—and get a loan in DAI tokens. The loans are built on so-called smart contracts—a type of software program on the Ethereum blockchain that can automate transactions without a middleman.

Traders use these loans to essentially trade on margin, using DAI to buy more Ether. Supporters believe these automated loans eventually could be used for other types of personal and business lending, enabling people to access capital without meeting the requirements of a traditional bank.

Compound Labs Inc. also is involved in a type of crypto-lending, having developed something similar to a money-market account for stablecoins. Traders can stash their stablecoins (or other cryptocurrencies) and earn interest with Compound, or they can borrow stablecoins or other crypto assets from Compound by placing 150% collateral on the platform. Rates fluctuate based on supply and demand, and users can pull their money out at any time.

San Francisco startup Dharma, meanwhile, enables people to lend out certain types of stablecoins (or Ethereum tokens) to others on its platform for set periods at set interest rates.

Eventually, supporters say, stablecoins could be used in a variety of ways, including in the creation of payment systems for people in developing countries who don’t have access to banks. Some analysts, however, say this won’t happen soon.

“Many countries don’t have the infrastructure,” says Larry Cermak, head analyst at crypto research firm The Block. “You can’t do much with [stablecoins] unless someone accepts it. The only thing you can do is send it to people—unless you convince merchants to accept it, which isn’t happening. That’s years off.”

Mr. Geron is a special writer for The Wall Street Journal in San Francisco. He can be reached at tomio.geron@wsj.com.

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