What is a stablecoin? In the world of cryptocurrency, there are thousands of coins, but (depending on who you ask) there is a far smaller pool of stablecoins compared to others. The nature of stablecoins makes them a bit more complex than virtual currency like Ethereum or Dogecoin.
Stablecoins are virtual currencies that are tied to a real-world asset like the U.S. Dollar. Stablecoins, by their very design, are intended to be less volatile than Bitcoin and others not backed by fiat currency. But that design is not bulletproof, and the collapse of one stablecoin (Tether) had a chilling effect on parts of the crypto industry.
Bitcoin, Ethereum, and others are virtual currencies have only the enthusiasm of the investing marketplace to provide value. These are not stablecoins. They are investments subject to a great deal of volatility and when you own them you own something that may not be worth the same amount tomorrow.
Whether that value goes higher or lower depends greatly on market forces, fear, excitement, hype, etc. Much noise has been made about Elon Musk’s apparent ability to influence the value of Bitcoin in particular just through social media posts on Twitter.
But stablecoins are quite different in many ways. While still operating as virtual currency and all the implications that might carry, stablecoins differ for a very important reason–they are backed by actual money in the real world and not just investor enthusiasm.
You’ll see the term “fiat currency” used in this context. That phrase is the same as “real world money”. Crypto backed by real money has an advantage over Bitcoin in the most obvious ways–the fixed value.
Real World Backing
Most conversations about stablecoins and their backing by real-world assets focuses on cash. It’s true that real world money–the U.S. Dollar, the Japanese Yen, the South Korean Won, the New Taiwan Dollar, etc.–is used to back some stablecoins. The money could be placed into a reserve fund as collateral in such cases.
But currency isn’t the only thing that could back a stablecoin. Some sources discuss coins that are backed by commodities like precious metals (gold and silver), and coins backed by cryptocurrency holdings.
Some may not be backed by a single commodity, but a range of them–precious metals being a good example. You may find stablecoins backed by a combination of gold, silver, copper, and more.
It’s true that lumping these into the stablecoin definition technically violates the spirit of the concept but those on the other side of the argument say that in best-case scenarios the assets backing the currency are bigger and less likely to fail.
But ultimately the definition in this context may be in the eye of the investor, to paraphrase the old saying about beauty.
Types Of Stablecoins
In the past, several coins stood out from the pack; where these projects will wind up as the march toward regulation continues isn’t clear but these are some of the bigger names in the stablecoin space. Not all of these coins are backed by currency; some are backed by assets or even commodities. Some sources indicate a number of stablecoins–some 36 in all. Others claim there are some 200 stablecoins. Some of the best-known stablecoins include:
- Tether was founded in 2014 and features a one-to-one exchange rate with the Dollar.
- Dai is a stablecoin backed not by cash, but by Ethereum-based currency.
- Binance USD is thought to be among the most popular stablecoins and one of the most prolific.
- TrueUSD is described by some sources as a “completely collateralized” stablecoin. TrueUSD is tied to the Dollar on a one-to-one basis.
- USD Coin is a joint operation between Coinbase and Circle, with the virtual currency secured by “dollar-based assets”.
- Digital Gold Token(DGX) is a stablecoin secured by gold rather than paper money. DGX promises the ability to physically verify the gold in your account.
The Collapse Of TerraUSD
Typically, stablecoins get their value from a cash reserve; investors who want to cash out should be able to pull their funds and the cash reserve will shrink accordingly. That one transaction isn’t enough to destroy the process.
TerraUSD operated as an “algorithmic stablecoin”. That is a process that depends on much more than a simple reserve of real-world money to function. TerraUSD relied on coding, market behavior, and good faith to stay tied to the U.S. Dollar. But a perfect storm of volatility was brewing.
Time Magazine reports that over a six-month period, and ending with the 2022 TerraUSD crash, the UST project offered investors a deal; buying via a platform called Anchor and lending that crypto to Anchor resulted in a 20% payout to the investor. Some immediately cried foul, noting that there was no way Terra could sustain those payouts indefinitely.
In May of 2022, TerraUSD started to drop in value to the point that it was no longer worth the equivalent in U.S. Dollars. The price went as low as 30 cents on the dollar. When investors began pulling their money out of TerraUSD en masse, the reserve fund couldn’t handle the panic.
Some believe that a bull market creates conditions favorable for stablecoins, while a bear market not only pulls things in the opposite direction but also exposes any weakness or flaws in the stablecoin.
What To Know About Stablecoins
Spectacular crashes like TerraUSD draw the attention of federal regulators A Presidential working group called for actions to regulate stablecoins, and Treasury Secretary Janet Yellin has been quoted saying there’s a need for “comprehensive” regulation in this area.
Yellin points to the kind of run on banks that triggered the Great Depression as a similar potential problem to the collapse of TerraUSD — with similar protections needed.
Going forward, the promise of regulatory oversight on the crypto industry is likely to have powerful effects on the price of coins, NFTs, and metaverse use. Only time will tell how extensive the regulations might be and how they affect trading crypto. While the name “stablecoin” promises something with less volatility than Bitcoin or Ethereum, there are no guarantees.
When you invest in a highly speculative marketplace, expect both hype and reality to play a part in your decision-making. It’s never safe to invest in coins, NFTs, or exchanges without knowing who the players are, their online reputations, and the results of past projects those players have been involved with. The same is true for any coin; you need to know who is behind the coin, the platform, etc.
The Advantage Is the Disadvantage?
Some investors point out that the reason why Bitcoin fascinates some speculative investors is linked to the biggest drawback of crypto-volatility. The ability for Bitcoin to soar into the four-figure range, the five-figure range, etc. is tied to that volatility, at least in part.
If you are betting on the volatility (or against it), rather than hoping for some sort of stability to emerge, you’re getting into the mindset some speculative traders have when they approach virtual currencies. Those who seek more stable investments won’t find much to encourage them in the crypto world. Buy and hold? That is a tricky proposition in this environment.
A stablecoin won’t unexpectedly go up to $30 million per coin and beyond the way Bitcoin did–the coin’s value is tied to a real-world dollar amount and therefore isn’t affected in the same way by market forces.
Now if the value of the fiat currency backing the coin drops, that’s a conversation for another article. If the U.S. dollar is strong, the cryptocurrencies backed by it would carry–at least on paper–the same buying power. If the dollar is weak…
That’s not to say that there aren’t forces that affect stablecoins, but not quite in the same unrestricted way the whims of the market do including some countries like China outlawing cryptocurrency transactions altogether.
Stablecoins provide a way for investors to build in safer investing practices than for Bitcoin or Dogecoin. You could hypothetically cash out at the end of your trading activities, go on with your life, and buy back in at a later time.
But with Bitcoin, you’re either buying, selling, or trading Bitcoin itself and it may be tougher–you may need to find an exchange, a willing buyer, etc.
Is Investing In Stablecoins Safe?
The same consideration for any investment should be made when you invest in stablecoins of any kind. Just because the investment is backed by real world money does not erase the potential for scammers, hackers, and opportunists from moving in with their schemes. You should be mindful of the risks inherent with any type of investing when considering these options.
It’s true that stablecoins offer, as the name implies, a greater degree of stability for that particular type of investment, but the nature of investing in crypto is similar no matter what kind of approach you take.
You’ll need to do your due diligence, explore service provider reputation and customer feedback, and other research for every type of investment you want. Stablecoins are no exception.
Joe Wallace has covered real estate and financial topics, including crypto and NFTs since 1995. His work has appeared on Veteran.com, The Pentagon Channel, ABC and many print and online publications. Joe is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News.