So, doing a little digging around the legitimacy of a given coin can help you confirm whether it’s a risky investment or not. For example, if a coin has never been audited, this could be a red flag, which means the claims its developers have made have not been officially confirmed. The first thing to check when investigating a stablecoin is what it’s backed by. Different stablecoins have different collateral, while others technically don’t have any collateral at all. So it’s important to determine what, exactly, your chosen stablecoin is backed by to understand how reliable it is.
- This means the value of these assets can quickly implode if new users stop coming.
- Stablecoins are typically pegged to a currency or a commodity like gold, and they use different mechanisms to maintain their price peg.
- The proposed rules focus on stablecoins that are deemed systemically important by regulators, those with the potential to disrupt payment and settlement transactions.
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 common transactions. Stablecoins are used as stores of value or units of account, as well as in other use cases where volatile cryptocurrencies may be less desirable. Different stablecoins use different strategies to achieve price stability; some are centralized, others are decentralized.
How to Use Stablecoins
However, since cryptocurrencies are so volatile compared to fiat currency, crypto-backed stablecoins are usually overcollateralized to help maintain their peg during times of market volatility. For instance, the Dai (DAI) stablecoin issued by MakerDAO is collateralized at 150%, meaning every 1 DAI in circulation is backed by 1.5x its equivalent value in Ethereum (ETH) or other cryptocurrencies. Or some keep part of the funds in fiat currencies and invest the rest of the collateral.
The first, most popular method is by backing up every stablecoin in supply with an equivalent value in fiat currency or cash equivalents. This means for every one of the stablecoins in circulation, an equivalent of 1 USD is held on reserve in U.S. bank accounts owned by the issuer. These reserves are routinely audited by independent accounting firms, usually monthly, with details on its holdings prominently published for public viewing. The algorithmic stablecoins function as real central banks, defending the peg of their currency in the market. When the price of the stablecoin goes over the peg they buy assets and sell them when the price drops below the peg.
Buy, store, swap and spend stablecoins with BitPay
Risk premiums represent the additional compensation investors get for the added risk of investing in an asset (i.e., stablecoins). The risk premiums lower the value of stablecoins compared with their peg, which means buying cryptocurrencies with stablecoins becomes slightly more expensive than with fiat currencies. Like most digital assets, stablecoins are primarily used as a store of value and as a medium of exchange. These differ considerably in their form and usability but are all backed by investment-grade gold. Crypto traders leverage stablecoins to reduce fees when selling or purchasing other cryptocurrencies, since many exchanges don’t impose a fee for conversion to or from stablecoins.
- For instance, in November 2021, Senator Cynthia Lummis (R-Wyoming) called for regular audits of stablecoin issuers, while others back bank-like regulations for the sector.
- This is often done to mitigate fees, as a lot of exchanges don’t charge for crypto-to-stablecoin conversions.
- While you can already spend money via cryptocurrency, only certain companies accept such payments, and stablecoins aren’t currently hugely popular in this case.
- Obtaining a gold bar and locating a secure storage site, for example, is difficult and expensive in many areas.
To do so they might have to transfer across several exchanges, or even wait several days. The theory goes, if you create a currency that is ‘pegged’ or attached to a regular fiat currency like the US dollar or something else with a relatively stable price, it will prevent price swings. While you can already spend money via cryptocurrency, only certain companies accept such payments, and stablecoins aren’t currently hugely popular in this case.
Spend with merchants that accept crypto
Stablecoins can be backed by a physical commodity such as gold, by algorithms, or by government-issued fiat currencies. The most apparent benefit of stablecoin technology is that it can be used as a medium of exchange, bridging the gap between fiat and cryptocurrencies. Stablecoins can reach a utility entirely different from the ownership of legacy cryptocurrencies by reducing price volatility. With the crypto boom of 2017 behind us, investors are increasingly looking to stablecoins as a safer way to experiment with the technology. In the first half of 2020, the supply of stablecoins swelled by 94% to hit $11 billion in June.
Intraday swings also can be wild; the cryptocurrency often moves more than 10% in the span of a few hours. Some of the most popular are issued directly by exchanges themselves like USD Coin (USDC), Pax Dollar (USDP), Binance Dollar (BUSD) and Gemini Dollar (GUSD). Avoiding such fluctuations gives stablecoins reliability, which sets them apart from the rest of the coins and tokens in the market. As a result, many stablecoins have become hugely popular in recent years, such as USD Coin, BinanceUSD, DAI, and Tether. BitPay partners with thousands of top brands and retailers to enable direct crypto payments, including AMC Theaters, Newegg, Microsoft and many more. Check out our Merchant Directory for a curated listing of top companies that accept stablecoins for their goods or services from virtually any crypto wallet.
The first method stablecoin issuers use to make money is through the straightforward charging of redemption and issuance fees. At a market cap of $66.9 billion, USDT is currently the third biggest cryptocurrency, behind Bitcoin and Ethereum (ETH). However, it has been besieged by doubt around the reliability of its reserves for years. USDC is a stablecoin outlier in disclosing precise data regarding its assets and liabilities. There has long been controversy about the reliability of the collateralizing reserves regarding certain stablecoins (i.e., that the stablecoin’s liabilities are higher than its reserves). While cryptocurrencies and the crypto ecosystem may present interesting and rewarding opportunities, many investors are cautious to invest in them due to their extremely volatile nature.
Fiat or commodity-backed stablecoins
But like other investments, a falling economy or market can significantly impact a coin’s value, as many of them are tied in with traditional financial institutions. Commodity-backed stablecoins make precious metals and other commodities easy to carry and more divisible while maintaining the same value as their reserve. Gold, for example, can be used as a medium of exchange through these stablecoins and can even be lent out to earn interest. The first stablecoin was issued in 2014 and since then, they have gained traction, as stablecoins offer the speed and security of a blockchain while getting rid of the volatility that most cryptocurrencies endure. Stablecoins aim to provide an alternative to the high volatility of popular cryptocurrencies, including Bitcoin (BTC), which can make cryptocurrency less suitable for common transactions. Their primary distinction is the strategy of keeping the stablecoin’s value stable by controlling its supply through an algorithm, essentially a computer program running a preset formula.
Stablecoins allow users to ride out market turmoil without taking their holdings out of the ecosystem. Stablecoins are typically pegged to a currency or a commodity like gold, and they use different mechanisms to maintain their price peg. The two most common methods are to maintain a pool of reserve assets as collateral or use an algorithmic formula to control the supply of a coin. For instance, a stablecoin issuer may promise to hold $1 in a bank account for each of the cryptocurrency coins it creates.
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Stablecoin reserves are maintained by central entities that regularly audit their funds and work with regulators to ensure that the entities holding stablecoin reserves remain compliant. It means that to buy stablecoins directly from the issuers, users have to go through Know Your Customer (KYC) and Anti-Money Laundering (AML) checks similar to those on exchanges. These processes involve collecting users’ personal information, including a copy of their government-issued identification document. Some algorithmic stablecoins are known for losing their peg during black swan or unexpected events because the market volatility shoots upwards due to a lack of over-collaterization. An algorithmic stablecoin system will lower the number of tokens in circulation when the market price falls below the fiat currency’s price. Alternatively, if the token’s price exceeds that of the fiat currency it represents, new tokens are issued to bring the stablecoin’s value down.
Stablecoins have been issued on various blockchain networks that support smart contracts and are widely used throughout the DeFi space and on exchanges. Blockchain networks that support smart contracts allow applications like decentralized exchanges (DEXs) to be built on top of them. Decentralized exchanges are marketplaces where transactions are made directly between traders. Stablecoins can now be used to lend for rates better than those offered by traditional savings accounts or take out cryptocurrency-backed loans in the decentralized finance (DeFi) space.
You won’t make millions with stablecoins, but they’re more useful than you might think. TerraUSD now trades under TerraClassicUSD (USTC) since the Terra blockchain was officially halted and de-pegged from the U.S. dollar on May 9. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.
For instance, in November 2021, Senator Cynthia Lummis (R-Wyoming) called for regular audits of stablecoin issuers, while others back bank-like regulations for the sector. Because so many are directly issued by exchanges themselves, stablecoins are widely available for purchase. To start buying stablecoins, first choose a trustworthy exchange, then create an account, select the wallet of your choice and the amount you wish to purchase.
This is because stablecoins are pegged to or backed by a certain asset, be it a traditional currency, resource, or another kind of crypto. Since their stability is on par with fiat, stablecoins are often used for crypto payouts or remittances. This is particularly helpful when making cross-border payments, which can be costly and slow if using fiat. With stablecoins, these transactions settle quickly and without bank or wire fees. Typical examples include selling governance tokens that allow buyers to gain voting control over the stablecoin’s future or locking up funds into smart contracts on the blockchain to earn interest.
