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Stable coins are a specialized category of cryptocurrencies that are meticulously designed to maintain a stable value, typically by pegging their worth to a fiat currency like the U.S. dollar. This https://www.xcritical.com/ distinct characteristic sets them apart from other cryptocurrencies, which are often known for their extreme volatility and rapid price fluctuations. The total market capitalisation for stablecoins continues to rise and is now estimated to have reached over $180 billion. Moreover, the interconnectedness of stablecoins with the wider financial system continues to deepen. As reiterated (PDF 1.4MB) by the BIS, if left unchecked, these interlinkages could result in “risks from cryptocurrencies easily transfer(ing) to banks and other established financial institutions”.
Stability amid the volatility of crypto: Stablecoins explained
The combination of the best of cryptocurrencies, with the price stability of more traditional financial instruments, how does stablecoin work makes stablecoins a popular alternative for settling payments. This is especially true for cross-border transactions, where traditional banking infrastructure can be disconnected, making payments and settlements complex, slow and costly. Another type of digital asset similar to centralized stablecoins are central bank digital currencies (CBDCs). CBDCs are similar to centralized stablecoins, but they are issued by central banks and thus don’t necessarily have to be backed by fiat money in an off-chain bank account. CBDCs are considered legal tender by the government that issues them and are used for streamlining payments between both individuals and institutions. Centralized stablecoins are traditionally backed by fiat currency in an off-chain bank account that functions as the reserve backing the on-chain tokens.
Stablecoins just sound like the digital money I already use in my banking app. What’s the difference?
Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, licenses, auditors, and the business infrastructure required by the regulator. Fiat-collateralized stablecoins maintain a reserve of a fiat currency (or currencies), such as the U.S. dollar, as collateral, assuring the stablecoin’s value. Stablecoins are cryptocurrencies whose value is pegged, or tied, to that of another currency, commodity, or financial instrument. Stablecoins aim to provide an alternative to the high volatility of the most popular cryptocurrencies, including Bitcoin (BTC), which has made crypto investments less suitable for everyday transactions.
Benefits of stablecoins include:
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Wait, aren’t those same central banks considering issuing their own digital currencies?
More fundamentally, bitcoin has become so established that regulators who looked to stem its growth would likely face a backlash from businesses. Of that market, bitcoin is by far the largest cryptocurrency, with a market cap of almost $600bn, accounting for 48% of the entire market. Stablecoins, which are a category of cryptocurrencies (of which there are almost 100 varieties in circulation) is collectively worth almost $128bn, about 10% of the market. Stablecoins aim to provide an alternative to the high volatility of popular cryptocurrencies, which can make cryptocurrency less suitable for common transactions.
„In an ecosystem like cryptocurrencies, where volatility is typically high, this is an important property,” says Paul Brody, principal and global blockchain leader at Ernst & Young. „If you want to take advantage of blockchain technology without exposing yourself to the volatility in crypto prices, this is the way to do it.” The Terra collapse shows the need for regulation that defines stablecoins and what can qualify as a reference asset, and also puts in place clear consumer protections. Most major financial regulators are actively considering regulation for stablecoins, as well as the broader crypto asset ecosystem. However, until financial regulators clarify obligations, consumers should recognize the increased risks inherent in crypto. Because their value does not fluctuate as wildly as free-floating cryptocurrencies, they are more suited for use as a means of payment in everyday transactions and as store of value.
Outdated systems, and assets that are traditionally held as a long-term store of value, pose challenges for companies that are looking to act fast in markets. Stablecoins give rise to a parallel marketplace characterised by enhanced liquidity and reduced barriers. As a result, businesses have more agility to rebalance their portfolios, thereby optimising the overall worth of their holdings. Furthermore, stablecoins offer an attractive option for businesses operating in regions facing soaring inflation rates, as they can serve as a dependable, long-term store of value.
This backing keeps the stablecoin’s value, providing users confidence in its stability and reliability. Central banks and other regulators keep the prices of government-issued fiat money relatively stable. Stablecoins use reserves, like fiat money (the US dollar is popular as it benefits from the stability provided by the US Federal Reserve and the US high credit rating) and commodities or other physical assets, such as gold. Instead of using reserve systems or backed assets, algorithmic stablecoins use a fully algorithmic approach to adjust their supply in response to price fluctuations.
Frax (FRAX), a coin pegged to the U.S. dollar, operates on a “fractional-algorithmic” mechanism for its stablecoin, meaning it is partially backed by collateral and partially stabilized algorithmically. Frax aims to provide “highly scalable, trustless, and ideologically pure on-chain money” in place of fixed-supply digital assets like Bitcoin. True to their name, stablecoins are intended to be a stable crypto option to invest in, especially when compared to currencies that can have high volatility, like Bitcoin or Ether. In the case of crypto-collateralized stablecoins, stability is achieved through over-collateralization.
TrueUSD was launched in 2018 by TrustToken, a fintech company that specializes in creating tokenized assets. The stablecoin is one of several that TrustToken offers, with others including TrueGBP, TrueAUD, and TrueCAD, each pegged to their respective fiat currencies. As mentioned earlier, Binance USD is issued by Paxos, a regulated financial institution, which means that it is subject to strict regulatory oversight. The Paxos Trust Company, which issues BUSD, is audited monthly by a leading accounting firm to ensure that the number of BUSD tokens in circulation is equal to the number of U.S. dollars held in reserve.
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The stablecoin market is constantly changing, but the top five stablecoins according to market capitalization are Tether (USDT), USDC (USDC), Dai (DAI), Ethena USDe (USDE) and First Digital USD (FDUSD). Created by First Digital Labs, First Digital USD is a token designed to have an equivalent value of one U.S. dollar and secured by a custodian with a trust license. In addition, collateral is validated by an independent third party, lending transparency and credibility to any kind of financial reporting.
However, these algorithmic or „seigniorage-style” stablecoins haven’t caught on. „Another variation of stablecoins are on-shore and off-shore stablecoins,” says Stonberg, a reference to whether the stablecoin issuers keep the reserves within or outside the US, which could impact regulatory oversight. Tether is by far the most popular stablecoin, with a market capitalization of more than $65 billion as of this writing. However, many news stories have come out about the lack of transparency of Tether and its parent company and whether Tether has in fact backed its stablecoin with real assets. Stabilizing its value makes it more likely for stablecoins to be used in everyday commerce than cryptocurrencies, but it’s not that simple.
But the relative price volatility of many cryptocurrencies is a concern for businesses. That worry is addressed by stablecoins, a type of cryptocurrency that pegs its price to another asset, such as a fiat currency or commodity. The safest options may be those that hold fiat currency in regulated accounts. Or some keep part of the funds in fiat currencies and invest the rest of the collateral. They seek to provide fiat value and price stability in a blockchain environment where digitized (yet non-decentralized) cash may not be recognized. Although all stablecoins aim to maintain a pegged ratio to a given fiat currency, the assets they hold as collateral may determine the stability of their respective pegs.
Some of these assets are short-term corporate debt and debt obligations backed by the Government. Stablecoins use different methods and tools to stay stable, such as holding fiat money, cryptocurrencies, commodities and algorithmic trading. When investors want their money back, makers destroy their coins (burn) and send fiat money back to the investor.
The value is pegged to the U.S. dollar and the reserve is made up of Ether coins locked up in smart contracts. Their value (compared to American dollars, for example) doesn’t change over time. Regulators supportive approach towards stablecoins does not mean that bitcoin is about to face a challenging regulatory climate. For one thing, many regulatory measures cover all cryptocurrencies, including bitcoin.
- Stablecoins can be backed by cash, cash equivalents, commodity values, or the value of other financial instruments to maintain their peg.
- Using stablecoins as a trading pair for more volatile tokens like bitcoin can be a more efficient option for traders.
- In the current market, there are almost 200 stablecoins distributed globally, some of which are already released and some of which are in development.
- There are several different types of stablecoins, each with its own mechanism for maintaining its value.
- Learn more about Consensus 2024, CoinDesk’s longest-running and most influential event that brings together all sides of crypto, blockchain and Web3.
The final framework that would apply would likely be subject to additional BoE and FCA consultations, pending HMT’s legislative process. USDC has also been bridged to many emerging blockchains by third-party bridges, resulting in the creation of bridged forms of USDC such as USDC.e. Global payments can be made for less than a cent, so it’s affordable for anyone to send USDC. It can also swing the other way where the consumer gets the short end of the bargain. We all remember the infamous story of the person who bought 2 large pizzas in 2010 for 10,000 Bitcoin (valued at $690M at the all-time-high price in November 2021). [1] In theory, at least – the wind-down plans which will be required will, de facto, impose a capital requirement on asset-backed tokens.
This text is informative in nature and should not be considered an investment recommendation. Any investment or trading is risky, and past returns are not a guarantee of future returns. The paper garnered a lot of attention and has served as the inspiration for Basis, a stablecoin whose first iteration was shut down by the U.S.
