INVESTING

Intro to Stablecoins: The Crypto of the Future?

Cryptocurrency has become a popular way to trade digitally through blockchain technology, which acts as a digital public ledger for transactions. There are a variety of different cryptocurrencies in the market, and they have created a new way for people to potentially make money and invest in both the long-term and short-term. Stablecoins are a type of cryptocurrency. Though different from other cryptocurrencies like Bitcoin and Ethereum, stablecoins are usually backed by an asset, such as the United States Dollar (USD). Stablecoins may reflect a 1:1 value to the asset. This is intended to reduce volatility, resulting in stable prices with minimal fluctuation, and it may come alongside increased regulations by jurisdiction. Currently, Tether, also known as USDT, is one of the largest stablecoins backed by the USD. Although they are still relatively new, stablecoins in current circulation make up over $250 billion of the cryptocurrency market. Before investing, it may be beneficial to review the types of stablecoin available and the risks associated with them.

Types of Stablecoins

• Fiat-Backed: These stablecoins are backed by traditional currencies, such as the USD, to help maintain a steady value. They are guaranteed by centralized companies, who maintain reserves of the fiat currency equal to the stablecoin valuation. To allow for more stability, the stablecoin often reflects a 1:1 value to the currency.
• Commodity-Backed: These stablecoins are pegged to commodities, like gold, and operate like fiat-backed stablecoins. For example, if a company were to have $10 million in stablecoin, they would need $10 million or more in reserves to allow for the stablecoin to be used.
• Crypto-Backed: Other cryptocurrencies back these stablecoins, allowing for a more volatile asset. Much like the commodity-backed stablecoins, the company will have to hold reserves equal to or greater than the stablecoins’ worth.
• Algorithmic: An algorithm runs the creation and release of these stablecoins through a computer algorithm. If the price of the stablecoins in circulation rise above the amount of the reserves, it will release more coins to decrease price; if the price of the stablecoins drop, the algorithm will remove coins to increase price.

Risks

When considering investing in stablecoins, it is important to remember that, just like any investment, there is risk involved. “Stable” is the foundational concept, but there is potential for currencies, assets, and cryptocurrencies to lose value, which makes them not as stable as they seem. When considering investing, conducting thorough research before making any purchases can lead to the most educated decision.

• Depegging: Stablecoins can lose their value when the market is stressed, meaning they can lose their 1:1 ratioed value when the asset they are pegged to either gains or loses value. A depegging event can lead to issues of trust with users as they expect stablecoins to not fluctuate and maintain price stability in volatile market.
• Regulatory Risk: Stablecoins and cryptocurrencies in general are still new to the financial scene and subject to new regulations. Future regulations could impact how stablecoins operate or are taxed.
• Algorithmic Uncertainty: While algorithms can offer automatic stability for stablecoins, the algorithm could potentially fail in the volatile market when panic selling occurs leading to potential collapse.

Sources:

https://www.fidelity.com/learning-center/trading-investing/what-is-a-stablecoin

https://www.investopedia.com/terms/s/stablecoin.asp

https://www.coinbase.com/learn/crypto-basics/why-do-stablecoins-depeg