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What Are Stablecoins [PATCHED]

Cryptocurrencies were created to replace intermediary companies that are typically trusted with a user's money. By their nature, intermediaries have control over that money; for example, they are typically able to stop a transaction from occurring. Some stablecoins add the ability to stop transactions back into the mix.

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A stablecoin is one type of cryptocurrency that is designed to maintain a fixed value over time. The value of a stablecoin is typically pegged to a specific real currency, often the U.S. dollar. In this setup, one unit of the cryptocurrency typically equals one unit of the real currency. Unlike highly volatile cryptocurrencies such as Bitcoin, the price of stablecoins is not meant to fluctuate.

This structure stands in contrast to most cryptocurrencies, such as Bitcoin and Ethereum, which are backed by nothing at all. Unlike stablecoins, these other cryptocurrencies fluctuate greatly, as speculators push their prices up and down as they trade for profits.

While many stablecoins are backed by hard assets, others are not. Instead, these others use technical means (such as destroying some of the coin supply in order to create scarcity) to keep the price of the crypto coin at the fixed value. These are called algorithmic stablecoins, and they can be riskier than stablecoins backed by assets.

In addition, their stability allows many stablecoins to be used as a functional currency within a crypto brokerage. For example, traders might convert Bitcoin into a stablecoin such as Tether, rather than into dollars. Stablecoins are available 24/7, making them more accessible than cash obtained through the banking system, which is closed overnight and on weekends.

At first glance, stablecoins may appear to be low risk. In comparison to popular cryptocurrencies that are backed by nothing, they are. But stablecoins present some typical crypto risks and at least one of their own kind of risk, too:

And even then, stablecoin owners should pay careful attention to exactly what is backing their coin. The stablecoin Tether has come under fire for its disclosures on reserves. And those who think the cryptocurrency is fully reserved by actual dollars should be careful.

Many stablecoins are pegged at a 1:1 ratio with certain fiat currencies, such as the US dollar or the Euro, which can be traded on exchanges. Other stablecoins are pegged to other kinds of assets, such as precious metals like gold or even to other cryptocurrencies.

Initially, early crypto holders used stablecoins as a safe haven in the event of a market decline or crash. If the price of bitcoin began to drop rapidly, a holder could convert their bitcoin to a stablecoin within a matter of minutes on a single platform, avoiding potentially massive losses.

But stablecoins are showing promise in other emerging applications. For example, they could benefit industries and individuals that need to make international payments quickly and securely, from migrant workers sending money back to their families to big businesses looking for a cheaper way to pay overseas suppliers.

For decentralized cross-border lending, for example, stablecoins could help provide a secure, online environment for peer-to-peer (P2P) transactions to take place without needing to use a volatile cryptocurrency like bitcoin or pay fees to convert money into local currencies.

Fiat-backed stablecoins are backed at a 1:1 ratio, meaning 1 stablecoin is equal to 1 unit of currency. So for each stablecoin that exists, there is (theoretically) real fiat currency being held in a bank account to back it up.

However, although issuers of fiat-collateralized stablecoins typically claim that their cryptocurrency is backed by fiat currency at a 1:1 ratio, this is not always true. The stablecoin issuer might place cash reserves in other assets, such as corporate bonds, secured loans, or investments.

Such has been the case with Tether (USDT) and USD Coin (USDC), the most popular USD-backed stablecoins. Both have stirred controversy in recent years as their claims of a 1:1 stablecoin-to-fiat ratio have come under scrutiny.

Such is the case with the Pax Dollar (USDP) and Gemini Dollar (GUSD), two USD-backed stablecoins that are regulated by the New York State Department of Financial Services. The issuers of the two coins publish monthly reserve audits that are verified by independent accounting firms.

Commodity-collateralized stablecoins are backed by other kinds of interchangeable assets. The most common commodity to be collateralized is gold. However, there are also stablecoins backed by oil, real estate, and various precious metals.

For example, to get $500 worth of stablecoins, you would need to deposit $1,000 worth of Ether (ETH). In this scenario, the stablecoins are now 200% collateralized, and even in the event of a 25% price drop, the $500 worth of stablecoins are collateralized by $750 worth of ETH.

And if the price of the underlying cryptocurrency drops low enough, the stablecoins will automatically be liquidated. Additionally, they are often backed by multiple cryptocurrencies in order to distribute risk.

Remember, the US dollar used to be backed by gold, but that ended decades ago, and dollars are still perfectly stable because people believe in their value. The same idea can apply to non-collateralized stablecoins.

As demand increases, new stablecoins are created to reduce the price back to the normal level. If the coin is trading too low, then coins on the market are bought up to reduce the circulating supply. In theory, prices of these stablecoins would remain stable as they are driven by market supply and demand.

In South Korea, consumers can pay for their morning coffee with Chai. Crypto cards can also serve as a channel for stablecoins to enter mainstream spending. For example, both Visa and Mastercard have launched payment cards that allow transactions in USDC.

For example, an employer could set up a smart contract that automatically transfers stablecoins to their employees at the end of each month. This is especially beneficial for businesses that have employees all over the world, as it provides a way to sidestep the high fees and days-long process of transferring and exchanging fiat currency from, say, a bank account in New York to one in China.

Banks themselves could also lead the adoption of stablecoins for this purpose. Shinhan Bank in South Korea and Standard Bank in South Africa are testing out a proof-of-concept for using stablecoins for cross-border remittances.

In the event of a fiat currency crashing in value, local citizens could quickly exchange their crashing currency for relatively safe USD-backed, EUR-backed, or even gold-backed stablecoins, thus protecting them from further drops in value.

Few cryptocurrency exchanges currently support fiat currencies due to strict regulations. But the use of stablecoins allows exchanges to get around this problem and offer crypto-fiat trading pairs, by simply using a USD-backed stablecoin instead of actual dollars.

In the event of a crisis, stablecoins can be a fast and cost-efficient way to send humanitarian aid to another country. As they are traceable through the blockchain, stablecoins can also improve transparency and accountability in donations. (Read our What Is Blockchain explainer for more.)

The Tether scandal provides an example of how a stablecoin can go wrong. Fiat-backed stablecoins are centralized, meaning they are run by a single entity. This requires trust that this entity is actually backing up their stablecoins with real fiat.

Finally, even where stablecoins may offer the potential to streamline financial services, they will likely face pushback from local governments. For instance, in a country with high inflation rates, the government may look to block stablecoins pegged to foreign currencies in order to protect demand for the local currency.

A recent US Treasury report on stablecoins discussed the systemic risk that a single stablecoin could pose if it becomes widely adopted. The risk is especially high with centralized coins, such as those backed by fiat and issued by private organizations, as economic power would be disproportionately concentrated on a single entity.

The ease and speed of transacting with stablecoins is conducive to speculative trading of digital assets, which can threaten market integrity and investor protection, according to the US Treasury Department.

There is also a lack of clarity and transparency on how the prices of some stablecoins are determined. In the aftermath of Black Thursday, MakerDAO users claimed they were told they would take only up to a 13% haircut in a liquidation event. However, many users completely lost their holdings.

Factors that contribute to the risk of illicit activity include the increased use of stablecoins for cross-border transactions, the lack of global standards for stablecoin providers, the uneven implementation of AML/CFT standards among different countries, and the potential for anonymity when transacting in stablecoin.

The price of bitcoin, ether and other popular cryptocurrencies plunged this week as investors trimmed their losses and sought refuge in less volatile assets. One catalyst for this week's rout are growing concerns about so-called stablecoins, another kind of cryptocurrency that is supposed to protect buyers from the sharp swings typical of virtual money. 041b061a72


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