Stablecoins are a sort of cryptocurrency that is intended to have a constant value over time. A stablecoin’s value is often fixed to a single actual currency, most frequently the US dollar. In this configuration, one cryptocurrency unit generally equals one unit of fiat money. In contrast to extremely volatile cryptocurrencies such as Bitcoin, stablecoins’ prices are not intended to vary.
This article will explain how stablecoins function, the hazards they pose, and how to determine if a stablecoin is secure.
What Are Stablecoins And How Do They Work?
A stablecoin is a cryptocurrency whose value is tied to another asset, most often the US dollar or the euro, but other assets may be used. This kind of cryptocurrency is linked to the underlying asset, which ensures that its value remains consistent over time, at least compared to the currency to which it is tethered. Stable coin is as though the underlying asset, such as a digital dollar, has been converted to electronic form.
Stablecoins are often backed by the assets to which they are linked, since their purpose is to follow them. For instance, a stablecoin issuer often establishes a reserve with a financial institution that owns the underlying asset. Thus, a stablecoin might maintain a reserve of $100 million and produce 100 million coins with a set value of $1 each. If the owner of a stablecoin wishes to cash out the coin, the actual money may be withdrawn from the reserve.
This structure contrasts with the majority of cryptocurrencies, such as Bitcoin and Ethereum, which are completely unbacked. Unlike stablecoins, the values of these other cryptocurrencies vary significantly as speculators trade for profit.
While the majority of stablecoins are backed by tangible assets, others are not. Rather than that, these others utilize technological techniques (such as eliminating a portion of the coin supply to generate scarcity) to maintain the crypto currency’s price at a constant level. This is referred to as algorithmic stablecoins.
Why Are Stablecoins So Popular In The Cryptocurrency Market?
Stablecoins address one of the primary issues with many popular cryptocurrencies, namely that their extreme volatility makes it difficult, if not impossible, to utilize them for real-world transactions.
In this respect, Anthony Citrano, creator of Acquicent, a marketplace for NFTs, says that since digital currencies like Bitcoin and Ethereum are so unpredictable, it’s really difficult to price goods in their terms. Stablecoins circumvent this problem by being pegged to a recognized reserve currency.
Additionally, its stability enables the usage of several stablecoins as a functioning currency inside a cryptocurrency brokerage. For instance, traders might exchange Bitcoin for a stablecoin such as Tether rather than dollars. Stablecoins are accessible 24 hours a day, 7 days a week, unlike currency earned via the banking system, which is closed overnight and on weekends.
Additionally, stablecoins may be utilized with smart contracts, a kind of electronic contract that is automatically executed when its conditions are met. Additionally, the stability of the digital money helps avoid conflicts that may develop when dealing with more volatile cryptocurrencies.
Which Stablecoins Are The Most Popular?
Stablecoins often do not get the same amount of coverage (or excitement) as other cryptocurrencies, in part because they do not provide the same sort of “get rich fast” potential. However, the following are the top cryptocurrencies in terms of market value as of October 2021:
• Tether’s (USDT) market capitalization is $68 billion.
• United States Dollar Coin (USDC): $33 billion.
• TerraUSD (UST): $3 billion TerraUSD (UST): $3 billion TerraUSD (UST): $3 billion TerraUSD
Of course, these coins are little compared to the major cryptocurrencies, such as Bitcoin, which has a market capitalization of about $1.1 trillion, and Ethereum, which has a market capitalization of more than $400 billion.
What Are The Dangers Associated With Stablecoins?
Stablecoins may seem to be a low-risk investment at first look. They are, in contrast to popular cryptocurrencies (which are not backed by anything). However, stablecoins pose some of the standard crypto hazards, as well as one of their own:
• Security: Stablecoins, like other cryptocurrencies, must be stored someplace, whether in a personal digital wallet or via a broker or exchange. And this introduces dangers since a trading platform may be insufficiently secure or may have vulnerabilities.
• Counterparty Risk: While cryptocurrency seems to be very decentralized, transactions involve many parties, including the bank holding the reserves and the entity producing the stablecoin. They must take the necessary precautions (security, adequate reserve management, etc.) to ensure that the currency retains its value.
• Reserve Risk: The reserves that support a stablecoin are a critical component of the stablecoin ecosystem. These reserves serve as the last safeguard for a stablecoin’s value. Without them, the coin’s issuer cannot confidently guarantee the stablecoin’s value.
Stablecoins: How Secure Are They?
So how can you determine if a stablecoin is secure? You must study the tiny print on its issuer’s assertions carefully. And it is critical that you do, Citrano explains.
He further advises the trader to confirm the reserve statements of Stablecoins issuer. He went on to say that if the issuer does not offer reserve reports then the one should proceed with great caution.
And even then, stablecoin holders should exercise caution about the coin’s backing. Tether, the stablecoin, has lately been under scrutiny for its reserve declarations. Additionally, individuals who believe the cryptocurrency is completely guarded should exercise caution.
The corporation demonstrated that it had higher reserves than liabilities in its March 31, 2021, reserve report. That seems to be a good thing, but the devil is in the details:
• Approximately 76% of its reserves are in cash or cash equivalents (the vast majority of which is short-term corporate debt, also known as commercial paper).
• Nearly 13% are secured loans.
• Almost 10% is invested in corporate bonds, mutual funds, and precious metals.
These other assets may behave a lot like genuine cash, but they are not real cash.
If one looks carefully, less than 4% is cash, whereas the majority is short-term business debt. Furthermore, commercial paper is not equivalent to genuine cash, particularly in an emergency. If markets deteriorate, those assets (and other non-cash assets) may rapidly lose value, leaving the Tether crypto currency less than fully reserved at a time when it may be most needed.
Unless and until a stablecoin commits to keeping 100% (or more) of its reserves in cash, there is no assurance that cash will be available to redeem coins. In this instance, stablecoins’ value may prove to be far from stable. Stablecoin holders may find themselves on the losing end of a classic bank run, an unexpected outcome for a system that portrays itself as very contemporary.
Finally, the strongest assurance of a currency’s safety is widespread acceptance as a medium of exchange for goods and services. And in the United States, the only generally acknowledged currency — indeed, the only price in which items are finally priced — is the dollar.
Stablecoins give some of the stability that other cryptocurrencies lack, therefore rendering them worthless as money. However, users who use stablecoins should be aware of the hazards associated with their ownership. While stablecoins may seem to have reduced dangers during most periods, they may become the riskiest at times of crisis, when they should be the safest to hold.