Stablecoin is a type of cryptocurrency that is meant to keep its value constant over time. A stablecoin’s value is often fixed to a single actual currency, most commonly the US dollar. In this configuration, one unit of cryptocurrency generally matches one unit of actual cash. In contrast to extremely volatile cryptocurrencies like Bitcoin, the value of stablecoins is not intended to vary.
However, current revelations in the stablecoin market, including the drop of TerraUSD, have government regulators paying special attention to this region. In that regard, even the treasury secretary Mrs. Janet Yellen has mentioned that stablecoins don’t present a systemic financial risk but issued a caution that they’re indeed a fast-growing asset class that could become more and more important to the financial system. Meanwhile, even the Federal Reserve issued a paper outlining the ambiguity of what is truly underpinning stablecoins and the absence of control in that market.
If you can’t wrap your thoughts around how stablecoins work and what they represent, in this brief article, we’ll explain how stablecoins work, what risks they pose, and how to determine whether or not a stablecoin is trustworthy in today’s market.
How Do Stablecoins Work?
Stablecoins are frequently backed by the precise assets linked to them because their objective is to monitor an item. For example, when a stablecoin such as one from the USD Coin network is issued, the organization normally establishes a reserve with a commercial bank that maintains the underlying asset. As an example, a stablecoin may have $100 million in deposit and produce 100 million tokens with a set value of $1 each. If the owner of a stablecoin wishes to pay out all the coins, the actual money can eventually be withdrawn from the reserve.
This structure contrasts with the majority of digital currencies, including Bitcoin and Ethereum, that are insured by practically nothing. Unlike stablecoins, the prices of these other cryptocurrencies vary dramatically as speculators trade for profit.
What Is The Purpose Of Stablecoins In Cryptocurrency Trading?
Stablecoins address one of the major issues with many prominent cryptocurrencies: their extreme volatility makes it difficult, if not unattainable, to utilize them for real-world transactions.
Furthermore, because of their stability, many stablecoins may be utilized as functioning money within a crypto agency. Traders, for example, could exchange Bitcoin into a stablecoin like Tether rather than dollars. Stablecoins are available 24 hours a day, seven days a week, making them more accessible than currency received via the banking industry, which is shut overnight as well as on weekends.
Stablecoins could also be utilized with smart contracts, which are electronic contracts that execute automatically when their terms are met. The digital currency’s stability also aids in avoiding conflicts.
Which Stablecoins Are The Most Widely Used?
Stablecoins often do not receive the same amount of coverage (or excitement) as other cryptocurrencies, partly since they do not provide the same sort of “get rich quick” potential. However, the following cryptocurrencies are one of the most popular in terms of market value as of May 2022:
- USD Coin (USDC): $49 billion;
- Binance USD (BUSD): $17 billion;
- Tether (USDT): $82 billion.
Of course, these coins are little in comparison to the major cryptocurrencies, including Bitcoin, which has a market worth of about $400 billion, and Ethereum, which has a market cap of more than $242 billion.
Stablecoins’ Level Of Security
So how can you tell whether a stablecoin is secure? You must carefully study the issuer’s statements for all the details.
Owners of stablecoins should still pay close attention to the specifics of the coin’s backing. Tether, a stablecoin, has drawn criticism for its reserve releases. Those who believe that cryptocurrency is entirely reserved for real currencies should exercise caution.
The corporation demonstrated that it has higher reserves than liabilities in its reserve report as of March 31, 2021. On the surface, that seems excellent, but the truth is in the specifics:
- The majority of its reserves—roughly 76%—are kept in the form of short-term corporate debt, sometimes referred to as commercial paper.
- Secured loans make up around 13%.
- Corporate bonds, investments, and precious metals make up close to 10%.
- Although these other assets frequently behave like genuine cash, they are not actual cash.
If you pay close attention, you’ll see that less than 4% of it was genuine cash and the majority was stored in short-term corporate bonds. In an emergency, this business cash is not the same as real cash. When it may be most necessary for the Tether token to be completely reserved, those assets (along with the other non-cash holdings) might swiftly lose value if markets fall. The price of stablecoins may turn out to be far less stable in this situation. Stablecoin owners may lose out in a traditional bank run, which would be an unexpected outcome for them.
Most cryptocurrencies lack stability, which prevents them from being used as genuine money. Stablecoins fill this gap. However, users who use stablecoins should be aware of the hazards involved. While stablecoins may appear to have minimal dangers at most times, they might become the riskiest during times of crisis, when it should be the safest to possess them.