Cryptocurrencies have gained momentum in recent years, despite various concerns and criticisms regarding the use case of cryptocurrencies. Cryptocurrencies are digital or virtual currencies built on the Blockchain, cryptographically secured, and generally designed to function as a medium of exchange.
Cryptocurrencies had a bull run in 2021 with Bitcoin, the first cryptocurrency, surging from around $7,000 in 2020 to an all-time high of around $69,000 in 2021. However, in July 2022, the price of Bitcoin fell to lows like 17,800 USD. Despite its volatility, or perhaps because of it, cryptocurrencies have captured the world’s attention.
The volatile nature of most cryptocurrencies has led to the need to create a cryptocurrency that possesses the fundamental qualities of cryptocurrencies but has a level of stability that makes it a trustworthy asset. This category of cryptocurrencies is called “Stablecoins”. Stablecoins are cryptocurrencies whose value is tied to other assets such as fiat currency or commodities. Thus, stablecoins are designed to avoid the volatility inherent in other cryptocurrencies whose prices are entirely determined by the market.
As a result, stablecoins are similar to our traditional view of money compared to other cryptocurrencies and have received more acceptance than other cryptocurrencies.
It was noted that in the presence of an appropriate regulatory framework, stablecoins would have the potential to play an important role in retail and cross-border payments. Nonetheless, the regulatory and licensing requirements for issuing stablecoins are quite tricky and require a lot of nuance depending on how the particular stablecoin works.
Overview of stablecoins
As pointed out earlier, Stablecoins are cryptocurrencies tied to other assets which could be fiat currency like Naira or US Dollar or could be a commodity like gold. This stability is critical to the use case for stablecoins, and coins that lose their peg (i.e., are unable to maintain parity with the commodity or currency to which they are pegged) often do not survive. to their disengagement.
Stablecoin issuers can achieve price stability by (a) using collateral, (b) using algorithms, or (c) merging collateral and algorithms.
Also Read: Nigerians Need Enough Information About Cryptocurrency – Owolabi Sunday
Warranties
Where the Issuer chooses to use collateral, such collateral may be fiat currency, commodities or other cryptocurrencies.
Fiat-backed stablecoins are fully or partially backed by government-issued fiat currency, such as the Naira, Pound, or US Dollar, often with a 1:1 ratio. A central entity, acting as an independent custodian, typically manages the process and ensures that equivalent fiat currency is held as collateral for each token issued.
Commodity-backed stablecoin works similarly to fiat-backed coins. However, instead of being backed by fiat currency, this type uses other types of assets and interchangeable goods, such as gold, diamonds, and precious commodities, as collateral.
For the last category, the value of collateralized crypto stablecoins is backed by other cryptocurrencies, rather than fiat or commodities – these stablecoins are often overcollateralized to account for collateral volatility.
The essence of using collateral is that the stablecoin can be redeemed or exchanged for the collateral held by the issuer. Collateral may be redeemable at a fixed value or at a variable value.
Algorithms
When the Issuer chooses to use an algorithm, the Issuer may either use a rebasing system or a seigniorage system. For Algorithmic Rebasing Stablecoins, otherwise known as Single Token Model, the total supply of Stablecoin is elastic and said supply is automatically adjusted to maintain the peg of the Stablecoin. For example, when Stablecoin is trading below its peg, the algorithm automatically reduces the supply of Stablecoin to push the price up. When Stablecoin is trading above its peg, the algorithm automatically increases the supply of Stablecoin to reduce the price.
For Seigniorage Algorithmic Stablecoins, otherwise known as the multi-token model, the Stablecoin is issued with at least one Sharecoin. Typically, when the Stablecoin price is trading below its peg, Sharecoins are used to reduce the supply of Stablecoins and when the Stablecoin price is trading above its peg, Sharecoins are used to increase the supply. offer of stablecoins. For example, under UST/LUNA, 1 UST can be exchanged for 1 dollar of LUNA, regardless of the actual trading value of the UST and vice versa.
Therefore, when UST is trading for less than $1, investors/users are incentivized to buy UST and trade it for LUNA (this increases the demand for UST and drives up the price of UST). ‘UST, allowing it to regain its peg) and where UST is trading above a dollar, investors/users are incentivized to buy LUNA and trade it for UST (this increases the supply of ‘UST’ UST and lowers its price, allowing it to regain its foothold).
Merge Collaterals and Algorithms
As mentioned earlier, Stablecoin issuers can also merge collateral and algorithms. This merger is called Fractional Algorithmic Stablecoins which combine the features of Fully Algorithmic and Fully Collateralized Stablecoins. These stablecoins avoid oversizing and have less custody risk. Unlike algorithmic-only designs, it seeks to impose a somewhat tight ankle with a higher level of stability.
Although Nigeria, like most countries in the world, does not have a regulatory framework dealing with the issuance of stablecoins, how and how a stablecoin is issued and how it maintains its peg determines the requirements. regulations that the issuer will have to comply with under the existing Nigerian legal framework. It must however be emphasized that this is uncharted territory in Nigeria and there are several gray areas.
We will look at these different gray areas, as well as where regulators stand when it comes to regulating virtual assets in Nigeria.
Davidson Oturu is a partner and head of the Intellectual Property and Innovation Practice Group at AELEX and Agboola Dosunmu is a partner in the firm.
