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Jan 14

Stablecoins: How Stable They Actually Are

Reading Time: 4 mins

There is a popular opinion that stablecoins are much safer than other coins. Is it true? Will the value of stablecoins hold up? This article will explain the role of stablecoins in the crypto market and the ways investors can benefit from them.

 

How Safe Are Stablecoins? Consider Potential and Risk

In today’s market, bitcoin is the most popular cryptocurrency. But bitcoin — and cryptocurrencies in general — owe a lot of this popularity to the propagation of various stablecoins.

Stablecoins have been around for quite a while now, and they provide convenient on- and off-ramps from fiat to crypto, and vice versa. Their growth has accelerated quite considerably in 2020 and 2021, and stablecoins make up a decent portion of the entire cryptocurrency market cap — around $150bin in December 2021. This has raised concerns among government fiscal agencies, which are trying to draw out a common framework to regulate stablecoins as soon as possible.

Many wonder how stable these cryptocurrencies are. Do they carry risk like other coins, or are they a safe haven for investors? In this article, we try to answer these questions and provide some insight into the risks and potential of stablecoins. We explore the technology that makes them possible, and provide a list of their benefits and drawbacks for investors. In the end, you should have a good idea of whether you should invest in stablecoins and the risks involved.

 

What Does Stablecoin Mean?

Stablecoins have “stable” in their name for a good reason. Unlike other cryptocurrencies, stablecoin is backed by real-world assets such as fiat money in private reserves, so their value doesn’t fluctuate when compared to fiat money.

How Do They Work?

Like other cryptocurrencies, stablecoins rely on blockchain technology for their transactions. This means that, even though they represent real money, they don’t have physical representations. As such, they inherit the benefits of other cryptocurrencies, including fast transactions, low transaction fees, and the inherent security of the distributed network. The fact that they retain the same value as the asset they are pegged to makes them an ideal method of online payment.

Moreover, cryptocurrency exchanges and trading platforms would have to go through a lot of trouble to provide their services if we didn’t have stablecoins. Imagine having to convert your BTC to USD each time you trade. This would be a nightmare scenario for traders, as fees would rise instantly.

Additionally, the growth of stablecoins has allowed merchants to be able to accept cryptocurrencies without worrying about the market’s volatility. Their convenience has become an integral part of the financial world.

And finally, stablecoins are considered one of the best ways to avoid high banking fees on remittances. Users can send them to one another instantly and pay cross-border invoices without being subjected to obscene fiat exchange rates.

What Assets Are Stablecoins Pegged To?

While the majority of stablecoins are pegged to various fiat currencies (EUR, USD, JPY, etc.), this is not always the case. There are three other types of stablecoins, including:

  • Crypto-backed stablecoins, which are issued tracking other cryptocurrencies’ reserves. For example, $30,000 of BTCUSD can be used to issue $15,000 worth of stablecoins.
  • Algorithmic stablecoins, which don’t rely on reserve assets for backing but instead use an algorithm to increase or decrease the total supply through burning to stay pegged to the fiat currency.
  • Commodity-backed stablecoins, which are collateralised by various commodities such as gold, silver, oil, etc.

In any case, they are designed to never fluctuate in value and always follow the value of the asset they represent.

How Are They Regulated?

Just like other cryptocurrencies, stablecoins are widely unregulated. There’s no common framework adopted by various governments regarding their regulation or classification as assets. Some consider them to be currencies, while others deem them securities.

This “wild west” has prompted governments around the world to accelerate their views on stablecoins and begin some sort of regulation. At the beginning of November, the US Treasury issued a report urging the regulation of stablecoins and underlining their importance in today’s financial environment.

The European Union has equally expressed concerns about stablecoins and has pledged to release the MiCA framework on stablecoins in the very near future. The goal is to classify these assets and provide legal grounds for development in this sector as well as merchant adoption.

 

What Risks to Consider When Investing in Stablecoins

There are two major risks if you wish to buy stablecoins as an investment. First and foremost, there is the underlying problem with regulations. Governments are still uncertain of the direction they will take on stablecoins. They might heavily regulate them, reducing their utility or outright banning their usage.

And the second major drawback is the risk that these coins aren’t really backed by real-world assets, but instead are just a simple bubble waiting to burst. The risks of centralisations are also very real, as stablecoins usually depend on a single issuer (eg Tether USDT), which makes them incredibly risky for investors.

 

What Benefits Can Stablecoins Provide?

The advantages of investing in stablecoins are quite substantial. We already mentioned their benefits as means of payment and transaction, but that would be just scratching the surface of the subject.

Stablecoins also allow investors to hedge against the volatility of the market. Traders can use them as a temporary off-ramp when the market is declining. They can hop right in whenever they want, as they remain in the crypto ecosystem.

Moreover, stablecoins can be used on various centralised and decentralised platforms for steady passive income. They usually provide stable interest rates, which makes them a low-risk investment that can yield between 3-5% on a yearly basis.

 

So, Are Stablecoins Safe Enough to Invest In?

To summarise, we can say that stablecoins are quite a safe haven for aspiring crypto investors. They can provide good yields, while at the same time allowing you to avoid the high volatility of the market.

That said, they aren’t perfect by all means. They still heavily depend on the value of the fiat currency they are pegged to, which has been experiencing heavy inflation in the past years. Also, you won’t be benefiting from the rising value of cryptocurrencies, as stablecoins will always retain their fiat value.

All in all, investing in stablecoins can be a great low-risk diversification method. They also retain a lot of crypto’s benefits, such as transferability, low fees, and speed, which makes them great versatile assets that can find their place in anyone’s portfolio.

 

Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.

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