An Intro To Stablecoins
Content:
General Information-
What Is a Stablecoin
Types of Stablecoins
Stablecoin Use Cases
Stablecoin Risks
Closing Thoughts
General Information-
1. What is a Stablecoin
Stablecoins are digital currencies that are pegged to a “stable” asset like another cryptocurrency, commodity, or fiat money. Because stablecoins usually have a “stable” value they are typically less volatile making them attractive to hold instead of volatile assets like Ethereum or Bitcoin. This may also make it more attractive to send across exchanges as it is less risky than other crypto assets. Stablecoins like USDC ($USDC) have gained traction as they’ve held their peg and are easily tradable.
2. Types of Stablecoins
There are a few types of Stablecoin that we will cover. The first kind of Stablecoins is Fiat-Collateralized. Fiat-Collaterilized stablecoins are like $USDT and $TUSD which claim to be backed by the US dollar. Another type of Stablecoin is the Algorithmic type. Algorithmic stablecoins rely on an algorithm and may or may not rely on a reserve asset to keep the peg. Algorithmic stablecoins are like $UST with had an unfortunate collapse. The last example of Stablecoins is the Crypto-Collateralized type. Crypto-Collateralized stables are like $DAI which are backed by other cryptocurrencies.
3. Stablecoin Use Cases
Due to the demand for Stablecoins, they have been growing exponentially since 2020 per Figure A. The use case of stablecoins has been growing alongside the growth of the demand and what is yet to come. What can you do with Stablecoins? That depends on who you ask but here are a few reasons why people prefer to hold stablecoins. (1) Reduce Volatility - As mentioned earlier, one might like to hold stablecoins since the value doesn’t fluctuate like $BTC and $ETH. (2) Earn Interest - Stablecoins may offer users a yield the same way a bank would offer interest. (3) Sending Money - Using stablecoins like USDC, one can easily send money to a friend or even internationally with fees less than a dollar.
Figure A
4. Stablecoin Risks
Today stablecoins have been under scrutiny by regulators. As we have watched the rapid growth of stablecoins, it impacts the financial system more than one may imagine. Politicians have requested tight policies against stablecoins and also request audits. Stablecoins also possess risks that one might not expect like a freeze. On July 8th, 2020 Circle confirmed a freeze on 100k USDC per a law enforcement request. Another risk is stablecoins losing their “stable” value as we saw with $UST. It is important to note, that no stablecoin is legal tender and that one must assess all risks before holding any stablecoins.
Closing Thoughts
While Stablecoins are fairly new, they do possess attractive qualities that would greatly benefit the industry. But as we speak there are only a few stablecoins that are transparent with their reserves and backing of their digital stablecoins. This is a sign that we are still early in the development of stablecoins and that more will emerge and others will gain more dominance. Additionally, the lack of clarity by US regulators hurts USA’s innovation as most of the development is happening within the USA. Until regulators provide clarity and declare what is and is not security, Stablecoins will never be able to reach their full potential. I do believe, that over the coming years the USA will provide clarity, but until then one must assess risk before holding any stablecoin.