What Are Stablecoins In Crypto Used For?

Stablecoins were a hot topic in 2021, as the Federal Reserve, U.S. Treasury Department, the White House, and Congress debated their merits. This class of cryptocurrency combines the best of both the crypto and legacy financial worlds.

But what are stablecoins in crypto used for and should you buy them?

Cryptocurrencies are part of a volatile sector of finance, many with real world valuable applications while stablecoins like Tether ($NUSDT) have been linked to potential price fixing scandals which doesn’t help their reputations among newbies.

In fact, Tether’s website was changed over the years to clarify that it may not be fully backed by the fiat currency it’s pegged to. These days, it’s backed by “traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties.”

That led to the 2017 leak of the Paradise Papers, which established the connection between Tether and crypto exchange Bitfinex that may have significantly contributed to Bitcoin’s historic price inflation later that year.

We explore stablecoins to determine why they’re such a hot topic and figure out if they have a place in your portfolio of cryptocurrencies.

What Is a Stablecoin?

Bitcoin ($BTC) is the apex cryptocurrency, and its price can affect the entire industry. Its price is notoriously volatile, dropping to $5,000 in 2020 before rising to over $60,000 in 2021, falling back to $30,000, and skyrocketing again to $60,000 within the same year.

This type of volatility makes it a scary investment for conservative investors. It also limits is potential use as a means of payment when both consumers and businesses can take big losses in the time a payment takes to clear.

In fact, May 22 is forever known as Bitcoin Pizza Day, thanks to Laszlo Hanyecz paying 10,000 BTC for delivery of two Papa John’s pizzas in 2010. Today, those pizzas are worth just short of $600 million, making them the most expensive pizzas ever bought.

Enter stablecoins, which have a value pegged to another asset. These coins are becoming a more popular (and often cheaper) method of everyday payments. And they can help hedge against crypto deflation.

There are three types of stablecoins.

Stablecoins Backed by Fiat

Fiat-backed stablecoins like Tether and Coinbase’s USD Coin ($USDC) are backed by fiat currencies. These traditional currency reserves are used to collateralize the coin supply.

Fiat-collateralized stablecoins can also be backed by precious metals like gold or commodities like bananacoin.

Whether these companies have reserves to back their coin supply is one of the main questions regulators have. To assuage price manipulation accusations, independent auditors are assigned to ensure liquidity reserves match the supply.

Stablecoins Backed by Crytpo

Crypto-backed stablecoins like MakerDAO ($DAI) are built on the Ethereum ($ETH) blockchain and backed by ether. The price is still pegged to the fiat currencies like the U.S. dollar, but the reserves are held in cryptocurrency.

This means crypto-collateralized stablecoins need to hold much more in reserves to account for wild price swings between crypto and fiat. And they work hard to ensure the price truly remains stable, much like the next type.

Non-Collateralized Stablecoins

Algorithmic stablecoins like Ampleforth ($AMPL) and DefiDolalr ($DUSD) are not collateralized – instead they rely on a consensus mechanism to ensure stabilization. They work much like a central bank or federal reserve, creating and destroying the cash supply as necessary to maintain the proper level.

These coins are typically run via automated smart contracts on a decentralized or distributed blockchain network. Because they’re not backed by anything, these are the most likely stablecoins to receive regulatory heat.

How Many Stablecoins Are There?

CoinMarketCap currently tracks 70 stablecoins, and that number can change at any time. The possibilities are nearly infinite. Each stablecoin can also be pegged to 200 fiat currencies, and there are around 6,000 cryptocurrencies they can be backed by.

This leaves a wide-open market and plenty of room for price manipulation and lost funds. That’s why regulators in the U.S. are starting to eyeball the industry.

Are Stablecoins Safe?

The biggest problem (or solution, depending on your perspective) is that stablecoins aren’t regulated the same way banks are. It’s a $138 billion segment of the crypto industry, and the President’s Working Group on Financial Markets made it clear it wants Congress to implement strict oversight.

This group includes representatives and leadership from the Treasury Department, Federal Reserve, SEC, CFTC, Office of the Comptroller of the Currency, and the FDIC.

However, Federal Reserve Board Governor Christopher Waller disagrees that stablecoins should be subjected to the same scrutiny as banks. It’s also researching whether the U.S. government should issue its own digital dollar.

With these ongoing issues, it’s natural to wonder if you should buy stablecoins at all.

Are Stablecoins A Good Investment?

Stablecoins are best used to manage volatility and make payments. Their value in relation to standard inflation are much easier to manage for both consumers and organizations. This makes them an easier (and often cheaper) way to move funds.

Countries with unstable fiat currencies can also depend on stablecoins pegged to the value of a more powerful fiat like the U.S. dollar. And there are plenty of ways to lend stablecoins out to earn interest.

But it’s still important to understand they can be just as unstable of an investment as any other should the underlying business go belly up.

What Is The Purpose Of Stablecoins: The Bottom Line

Stablecoins are a class of cryptocurrency that have their value pegged to a fiat currency. They are typically backed by reserves of cash, crypto, or commodities and audited regularly by a third party.

However, many regulators believe they need tighter regulation to avoid problems like illiquidity and price manipulation.

Still, usage of stablecoins continues to expand. They represent an easy way to hedge against volatile crypto markets. And they are also attractive for everyday payments when compared to bitcoin, which has more price volatility risk.

Many governments around the world are researching these digital currencies, so it’s a good idea to keep an eye on them. If you’re looking for a way to protect your crypto investments during market highs while earning interest, stablecoins could be the answer.

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