Stablecoins are a niche part of the ever-growing crypto ecosystem, primarily used by crypto investors as a convenient and profitable way to conduct cryptocurrency transactions.
But there is another key player with an eye on stablecoins: Uncle Sam.
US government officials are rushing to regulate stablecoins, which are different from other, more volatile types of crypto. Where Bitcoin and Ethereum rise and fall day by day and even hourly, stablecoins promise to hold their value as they are pegged to less volatile assets, such as the US dollar or the euro. Due to their potential use as real currency, U.S. government officials fear potential risks stablecoins pose for consumers and financial markets if left unregulated.
“A stablecoin is basically a coin that is pegged to another asset and acts almost like a reserve currency. It’s like a common denominator between other cryptocurrencies,” says Humphrey Yang, the personal finance expert behind HumphreyTalks.
Here’s everything investors need to know about stablecoins.
What are Stablecoins?
A stablecoin is a type of cryptocurrency that relies on a more stable asset as the basis of its value. Most often, people refer to stablecoins as tied to fiat currency, like the US dollar, but they can also have value tied to precious metals or other cryptocurrencies. Stablecoins are essentially a less volatile cryptocurrency with greater potential to resemble the types of currencies people already use every day.
“Its purpose is to provide price stability when people transact in coins or between fiat and digital currencies, as crypto markets can be volatile,” says Doug Boneparthfinancial adviser and president of Bone Fide Wealth in New York.
All stablecoins are backed by some kind of asset or a combination of assets in a reserve; it can be gold, cash, or even short-term corporate debt called commercial paper. The idea is that the reserve money acts as collateral for the stablecoin – each time a stablecoin holder cashes in their tokens, an equal amount of assets is taken from the reserve.
There are many types of stablecoins and not all are created equal. Tether (USDT) is known as the first and largest stablecoin, and it was created in 2014. Around 85% The advantages of Tether are cash, cash equivalents, short-term deposits and commercial paper, according to its website. “USDT is owned by Tether, so Tether should have $1 on hand for every stablecoin,” Yang explains.
USD Coin is another popular stablecoin that was launched in 2018 by Circle. The USD coin is pegged to the US dollar and short-term US Treasury bills with an outstanding supply of $49 billion, according to Circle. Other stablecoins like Dai, Binance USD, and TerraUSD are also popular, but have smaller market caps and different reserve allocations.
How do you use stablecoins?
Stablecoins are useful because they allow people to transact more seamlessly in cryptocurrencies that function as investments, such as Bitcoin or Ethereum. They form a bridge between volatile cryptocurrencies and stable real-world assets, like fiat. By trading with stablecoins instead of US dollars, you are able to maintain all of your trades within crypto exchanges, which can save you the fees you would likely be charged on many exchanges.
Suppose you have Solana and Ethereum and want to buy more Solana with your Ethereum. You can exchange your Ethereum for stablecoins, like USDT, at a value in US dollars and from there you can buy more Solana with your stablecoins. Since Solana and Ethereum are separate blockchains and remain largely isolated from each other, using stablecoins as an intermediary can save you on fees and maintain the value of your crypto during trading periods. volatile.
“Sometimes a conversion from Solana to Ethereum is a bit more difficult because they’re on two different layers, like in two different projects, but the stablecoin acts as the common denominator between the two,” Yang explains.
Although crypto traders sometimes use stablecoins for more advanced investments, such as staking and lending, most beginners use them to avoid trading fees. Many crypto exchanges do not charge fees when exchanging US dollars for stablecoins. Coinbase, for example, does not charge any fees on transfers between USD Coin and US Dollar.
Another use for stablecoins is in international remittances or sending funds across international borders, although this can be risky as there is little or no official regulation. Since stablecoins are a form of private money, i.e. money backed by a company and not by the government, there is a real risk that stablecoins will not be as stable as one would expect. claims so, especially in times of economic hardship. There are also security and fraud issues. Essentially, if you put your money in stablecoins, there’s no guarantee you’ll get it back.
Can you invest in stablecoins?
Stablecoins are used as a niche currency in the crypto world and are not big investments. They are better suited for digital transactions and converting digital assets to and from “real” money.
Since crypto trading and prices can go up or down very quickly, it may be easier, faster, and cheaper to trade coins for stablecoins than to trade coins for real dollars in and out of your bank account. For example, you could quickly convert your Bitcoin into stablecoins pegged to the US dollar, like USDT, and it would continue to live on the exchange you operate on and retain its value. You can then exchange these stablecoins for other coins. If you were to convert your Bitcoin directly to US Dollars, it might take longer to enter your bank account and actually withdraw it from the crypto exchange.
“You don’t want to lose money just by switching between currencies,” says Boneparth.
The future of stablecoins
Regulation is likely to be an important topic for stablecoins in 2022, experts say. Like other cryptocurrencies, stablecoins operate outside of the U.S. monetary system, and officials have repeatedly raised concerns about them falling through the cracks of the regulatory net.
Federal authorities such as Securities and Exchange Commission (SEC) Chairman Gary Gensler, Federal Reserve Chairman Jerome Powell, and Treasury Secretary Janet Yellen, among others, are primarily concerned about stablecoins because these types of crypto have the most potential for future use by everyday consumers. to buy things. For this reason, expect continued conversations about stablecoin regulation this year, and possibly even legislation, experts say.
“I think 2022 will be a bigger regulatory year than any year before,” Boneparth says. “The more mainstream crypto becomes, the more attention regulators and policymakers are going to pay to it.”
Stablecoins have been “scrutinized” in particular because regulators are unsure what to make of them and are rushing to figure out how to establish laws and guidelines on how to deal with stablecoins, Boneparth says. It’s unclear whether U.S. regulators will choose to treat them like securities, banks, or something else entirely. The White House plans to release an initial government-wide strategy for crypto and other digital assets, and will ask federal agencies to assess their risks and opportunities, according to a Bloomberg Report.
This debate is also linked to another hot topic: will the Federal Reserve come up with its own central bank digital currency (CBDC). The Fed released a long-awaited report in January exploring the pros and cons of a CBDC, but postponed a final decision on whether to move forward. Instead, the Fed is giving the public and other stakeholders until May 20 to provide feedback before taking further action. The Fed acknowledged in the report that the move “would represent a very significant innovation for the U.S. currency.”
According to Grant Maddox, a certified financial planner and founder of South Carolina-based Hampton Park Financial Planning, whatever the Fed does next could “fortify cryptocurrencies or hurt their value.” “It depends on the direction our government chooses to take,” he recently told NextAdvisor.
Additionally, some experts say that the Fed’s planned interest rate hikes this year could boost demand for the US dollar and thus draw Americans’ attention to cash-backed stablecoins. Since the Fed is likely to raise interest rates multiple times this year, it “should basically provide tailwinds for the dollar” and “dollar-linked stablecoins can capture that rise as well,” according to Scott Bauer, a former Goldman Sachs trader. who is now CEO of Prosper Trading Academy, and as reported by Coindesk.
While that remains to be seen, it’s something to watch this year, and it could potentially affect any regulatory action the US government takes on stablecoins.