The value swings represent changing ideas in the minds of human beings about the value of the underlying currency.
If you want the value of a currency to be stable, you need to be in a position to economically support the stable price - if lots of people want to sell, the stabilizer must be prepared to buy a lot of the currency at the stable price. If a lot of people want to buy, the stabilizer must be prepared to sell a lot of the currency at the stable price. This is potentially a very, very expensive - and perhaps impossible - undertaking.
The first step is to not make it deflationary, which causes people to hoard it instead of spend it. Unfortunately BTC gained such popularity in part because of this property.
One cool way to do this that I've been thinking about is to tie the mining reward rate to the exchange rate somehow. This has the effect of more coins being created when prices are low, and less created when prices are high. In theory this should stabilize the price. The problem with this method is you need a way to measure the "price" in a decentralized way separate from any other currency.
One way to do THAT is to aim for a certain velocity of money (https://en.wikipedia.org/wiki/Velocity_of_money). Theoretically it should correlate to inflation: if people are hoarding, the *coin will gradually start to decrease in value until more people are spending. If people are spending like crazy, the value will gradually increase. Not sure if that is a good solution, just one that I thought up.
isn't a dollar or euro merely a deflationary currency that follows the velocity of money principle albeit controlled by the government and when the velocity is slow they print more?
Not exactly. First of all the currencies aren't deflationary, they're slightly inflationary, meaning they lose value over time. Deflationary currencies are considered very bad if a government holds much debt at all. Inflationary currencies incentivize spending over holding.
Second of all they don't just look at velocity of money, they also look at the economy's strength, demand for money and lending, consumer prices indicies, and other things that are tied to external metrics and thus need a centralized authority to use. For a cryptocurrency, we can't do this, we have to rely on some algorithm. Tying creation rate to velocity of money seems like a decent approximation to me, but I could be dead wrong.
It's not possible to have a 100% stable currency. At their core currencies are human opinions of how much to exchange for a product or service. But human opinion changes on a whim.
I think a currency could be stabilized by automatically adding coins to the total when people feel they want to hoard them, such as economic panics and reducing them when they feel they want to use it without care such as when the economy is booming.
It has to be automatic but finding a way to do that is the big question. But what and how? Use an index, maybe but it has to be impartial and give a true view of how people feel about the economy at the time.
For the US dollar the Federal Reserve is responsible for increasing and decreasing the money supply but they have truckloads of people telling them how the economy is doing.
A cryptocurrency has potential since in theory you can figure out exactly how people are using them.
Additionally, the supply has to increase as more people use it to create economic goods and services. If you don't, there won't be enough currency to go around and it will limit the potential products/services that people can create and consume.
As others have said, basically it's a problem of control. Normal currencies, in relatively normal times, are semi-managed by central banks. They use tools like reserve requirements and interest rates to influence the rate at which new currency flows into the general economy. It's possible for one bank to trade in the market in a way to peg one currency against another, as China did for some years. And it was costly, because they were doing it while trying to maintain a large trade surplus, so large numbers of dollars were coming in that needed to be neutralized somewhere. It's why they hold so much US debt. Real currencies get in trouble--severe deflation or inflation--when circumstances (the gold standard, external debts financed in another country's currency) make it hard to respond to economic conditions.
This becomes the question: can the system be designed to respond dynamically to demand in a way that mimics the actions of a central bank, without there actually being a central bank? If the goal was to make it so that it was reasonably constant in terms of purchasing power, there's probably a number of metrics one could choose to measure that, but how to achieve it, that's above my pay grade.
I'd say it all comes down to volume. If there's enough money in a currency or in fact any kind of asset it's much less volatile because it's much harder for single players with big pockets to move the needle in either direction.
This isn't really a design issue though (or one specific to cryptocurrencies) but one of making the asset attractive enough in the long term.
Even then larger up and down movements are still possible, for example as seen when George Soros decided to 'break' the Bank of England in 1992.
option (i) have a credible centralised monetary authority that promises to redeem it for its reserves of dollars or gold or whatever you want it to be stable against. Though arguably for the crypto-currency to actually be credible it needs that monetary authority to hold (or have the facility to borrow at short notice) the asset it's backing it with
option (ii) replicate the fiat system: i.e. the spendable currency is mostly credit with a future repayment obligation and thus actual future demand to hold the currency, and imbalances between rates of borrowing and repayment which drive the currency value up and down are kept in check by algorithmic adjustments to "interest rates" creditors face when borrowing to meet margin calls and "taxes" which make debtors have to buy even more coin to meet payment obligations.
(This still isn't going to work unless credit creators are regulated though...)
whether it's still a cryptocurrency after all that is another question....
You can't design a cryptocurrency with stable value. At least not without a central monetary authority anyway. A key selling point of cryptocurrency is that it (theoretically) exists outside of the influence of a central authority. But this very feature is the thing that will prevent it from ever having a stable value.
Because there's a limited amount of it, it's deflationary in nature. If a currency becomes deflationary, then it's not going to be a currency for very long. People will hoard it instead of using it in their everyday transactions.
Cryptocurrency gets most of its value from speculation. In the case of Bitcoin, at least, that speculation is spurred by some people's belief that it has importance as a potential future currency. It doesn't matter that they're wrong. Their beliefs are still enough to boost the price of the speculative asset. Then you have this cycle where its price will crash every so often. If Bitcoin's price ever stabilizes, it will be because most people have given up on it as a currency.
Once the hype dies down, the question is whether it can do what gold did and become a valuable asset with a relatively steady price. Will there be fringe Bitcoin bugs like there are gold bugs who create enough demand for it to keep the price from going to zero? I guess we'll see.
At its core, Bitcoin is gold. And if you want an answer to why we'll never be using Bitcoin as our currency, ask yourself why gold is never again going to be our currency. It's the same answer. Without a central authority, you can't keep the price stable.
Now we could certainly construct a credit structure on top of Bitcoin. So instead of trading Bitcoin directly, we trade IOUs for Bitcoin. That's what we did with the gold standard. If they're "just as good" as Bitcoin, then it effectively increases the circulation of Bitcoin-denominated assets and can help keep prices stable.
You'd of course need some kind of trusted authority to tweak various macroeconomic variables to ensure that the value of Bitcoin (or Bitcoin IOUs) remains stable. But it's possible at least for a while. You just have to give up one of the core principles of cryptocurrency.
Eventually you're going to have so much money circulating and so little actual Bitcoin to back it up that the system is going to become too brittle and you'll have to leave the Bitcoin standard.
Hey look. You just bootstrapped another fiat currency.
Bitcoin is gold. It can be manipulated by governments just as much as gold can. And it has just as much potential to be a real currency as gold does. For a long time there, we were lucky and we were mining new gold at roughly the rate required to keep prices stable. No such luck with the cryptocurrencies. And even if you manage to hit on the right rate of currency minting today, the future looks different.
Deflation/Austrian economics isn't a core principle of cryptocurrency; it's just a historical accident that Bitcoin works that way and it's also helpful for scams.
If you want the value of a currency to be stable, you need to be in a position to economically support the stable price - if lots of people want to sell, the stabilizer must be prepared to buy a lot of the currency at the stable price. If a lot of people want to buy, the stabilizer must be prepared to sell a lot of the currency at the stable price. This is potentially a very, very expensive - and perhaps impossible - undertaking.
See https://en.wikipedia.org/wiki/Monetary_policy for more.
Ultimately, value isn't something that's designed, it's the overall effect of a lot of individuals' preferences and guesses about the future.