How Safe Are Stablecoins Really?
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How Safe Are Stablecoins Really?
Investing Basics
September 26, 2022

How Safe Are Stablecoins Really?

A stablecoin is a digital currency that is pegged to another asset like Gold, or fiat currencies such as the Euro or the US dollar. The aim of a stablecoin is to provide a more stable alternative to traditional cryptocurrencies, which can be subject to large swings in value. The concept of a digital currency that is backed by a real-world asset has been around for some time. However, it was only with the launch of Bitcoin in 2009 that the idea began to gain traction. Since then, a number of stablecoins have been launched, with varying degrees of success.

According to Washington Post, the current market cap of stablecoins is about $180 billion, that's $175 million more than 2 years ago. The most popular stablecoin is Tether (USDT), which is pegged to the US dollar. Other notable examples include Paxos Standard (PAX) and Gemini Dollar (GUSD), which are both backed by the US dollar, and GoldMint (GOLD), which is backed by gold.

Let’s take a look at what stablecoins are, how they work, and whether they are a safe investment.

Key takeaways

  • A stablecoin is a digital currency that is pegged to another asset like Gold, or fiat currencies such as the Euro or the US dollar.
  • Stablecoins were created in part as a reaction to the price volatility that traditional cryptocurrencies like Bitcoin face.
  • There are two main types of stablecoins: those that are backed by real-world assets and those that use algorithms to maintain their price.
  • Stablecoins offer a number of advantages, including being more resistant to price volatility and being able to access the growing world of decentralized finance.
  • There are also a number of risks associated with stablecoins, including the risk that their value could still fluctuate and the risk that they may not be backed by a real-world asset.

What are stablecoins?

A currency is most helpful when it serves as a means of trade and a store of value, regardless of whether it is the US dollar or Dogecoin. For those activities, price stability is essential. Because of this, authorities work to maintain a general level of stability in the prices of conventional national currencies. 

A daily movement of 2% in forex trading of fiat currencies is a massive shift. On the other hand, for cryptocurrencies, a 2% change is considered normal and uneventful.

The price of Bitcoin can drop by 10% in a day and then recover those losses within the next few days. As you can imagine, these wild swings make it difficult to use cryptocurrencies as a means to trade or store value – and this is where stablecoins come in.

Stablecoins have values that are linked to those of real-world assets like the US dollar. They were created in part as a reaction to the price volatility that traditional cryptocurrencies like Bitcoin face, whose usefulness as a payment method is constrained by swift fluctuations in market value.

At the moment, stablecoins are a crucial part of the emerging category of goods known as DeFi, or decentralized finance, which allows for the execution of transactions without the need for an intermediary like a bank or broker. 

Certain stablecoins have some of the biggest market capitalizations on the cryptocurrency market, including Tether and USD Coin.

Recommended: What Are Stablecoins And How Do They Work?

Are stablecoins... stable?

One of the key selling points of stablecoins is that they are designed to be more stable than traditional cryptocurrencies, but not all stablecoins are created equal. Some are backed by real-world assets, while others simply use algorithms to attempt to maintain a stable price. Here's how stablecoins maintain their valuation:

Backed by real-world assets

The most common type of stablecoin is one that is backed by a real-world asset, such as the US dollar or gold. These assets are held in reserve by the issuer of the stablecoin and can be redeemed for cash or other assets if needed. The value of the stablecoin is then linked to the price of the underlying asset.

For example, Tether (USDT) is a popular stablecoin that is pegged to the US dollar. Every Tether token is backed by one US dollar, which is held in reserve by the Tether Treasury. If you want to redeem your Tether tokens for cash, you can do so at any time and you will receive one US dollar for each token.

Other stablecoins are backed by assets such as gold or oil. For example, GoldMint (GOLD) is a stablecoin that is pegged to the price of gold. Each GOLD token is backed by 1 gram of gold, which is stored in a secure vault.

Dante Disparte, Circle's CSO, one of the companies that created the USD Coin, said that they "took the dollar, the trust in the dollar, the buyers' and spenders’ security around how the dollar is a currency of choice around the world and then empowered it with the power of the internet."

Algorithmic stablecoins

Another type of stablecoin uses algorithms to maintain its price. Not backed by any real-world asset, these coins rely on smart contracts to keep the price stable.

One example of this is MakerDAO (MKR), which is a decentralized autonomous organization that creates and controls the Dai (DAI) stablecoin. The Dai stablecoin is pegged to the US dollar and its value is maintained through a system of smart contracts known as the Maker Protocol.

DAI is created when users lock up collateral in a smart contract. This collateral can be in the form of Ethereum (ETH), Bitcoin (BTC), or other assets. The value of the Dai is then linked to that of the underlying collateral. 

If the price of DAI begins to fall, more collateral is required to create new tokens. This system is designed to keep the price stable even if there are large swings in the value of the underlying collateral.

The future for stablecoins: final thoughts

While BOTS does not offer trading stablecoins yet, with the technology we have in place, we are considering starting to offer it in the future. Other platforms are already offering them as a trading option – a testament that these coins are growing in popularity thanks to their stability.

While some people are hesitant about stablecoins because they are not backed by a central authority, such as the US government, others view them as a way to protect themselves from the volatility of traditional cryptocurrencies.

What do you think? Are stablecoins a safe investment?

Disclaimer:

This blog is for educational purposes only. The information we offer does not constitute investment advice. Please always do your own research before investing.

Any views expressed in this blog and by BOTS do not constitute a recommendation that any particular cryptocurrency (or cryptocurrency token/asset/index), portfolio of cryptocurrencies, transaction, or investment strategy is suitable for any specific person.

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