A stablecoin is a type of cryptocurrency that is designed to have a stable value and minimize volatility. Stablecoins are pegged to an underlying asset, commonly fiat currencies like the US dollar or precious metals like gold. The peg helps stabilize the price and provides investors with greater price certainty compared to traditional cryptocurrencies like Bitcoin or Ethereum which can fluctuate wildly in value from day to day.
But with their stable prices, some may wonder why anyone would want to invest in stablecoins in the first place. After all, don’t investors want their assets to appreciate over time? Here are some of the main reasons why both individual and institutional investors are allocating funds into stablecoins despite their stable value proposition:
Preserve Capital During Volatility
Cryptocurrency markets are known for their extreme volatility. The price of top coins like Bitcoin and Ethereum can swing 10-20% or more in a single day, sometimes decreasing just as quickly as they rose. This makes pricing extremely difficult and introduces significant risk, especially for those looking to transact or hedge using cryptocurrencies.
Stablecoins allow investors to move into a crypto asset that protects the value of their capital during bouts of intense market volatility or uncertain times. Parking funds in a stablecoin can lock in gains realized from more speculative coins, or provide a safe haven during major sell-offs and crashes in the broader crypto market. Traders may rotate holdings into stablecoins like Tether (USDT) or USD Coin (USDC) when they expect volatility and don’t want to cash out to fiat. The stable price provides stability amidst the storm.
Facilitate Trading on Crypto Exchanges
Stablecoins are frequently used as a medium of exchange on cryptocurrency trading platforms and exchanges. Exchanges may not support fiat deposits or withdrawals, so stablecoins like Tether fill this gap by serving as a proxy for the US dollar or other fiat currency. Traders can seamlessly move between cryptos and stables to enter or exit positions, take profits, or trade one crypto for another without off-ramping to their bank. Stablecoins provide the speed, efficiency, and convenience of remaining within the crypto ecosystem.
Large stablecoin balances are kept on exchanges for trading purposes. Traders may hold stables to quickly take advantage of arbitrage opportunities across different exchanges. The ability to react and reposition funds faster than transferring fiat gives traders an edge.
Send Fast, Low-Cost Cross Border Payments
Sending payments with traditional banks can be slow and expensive, especially across borders. International wire transfers can take days and charge high fees. Stablecoins running on blockchain allow fast, low-cost global payments and remittances to anywhere in the world. Transactions settle in minutes, not days, and fees are a fraction of wired funds.
For example, a migrant worker could use a stablecoin to instantly send money back to their family in their home country. Rather than paying ~10% fees to transfer cash through traditional remittance channels, stablecoins allow near-instant delivery for less than a dollar per transaction. Stablecoins are faster, more affordable, and more accessible for cross border payments.
Earn Interest Yields
Holding stablecoins can generate attractive interest yields, far higher than keeping fiat dollars in a bank savings account. For example, deposit accounts at crypto lending platforms like Celsius Network pay up to 17% APY interest on stablecoins like USDC or Tether. This dwarfs the ~0.5% paid by traditional banks. Investors allocate to stablecoins to earn these outsized yields.
The interest comes from lending out stablecoins to institutions like hedge funds who use them for trading, arbitrage, or lending to crypto traders. Demand is high for stables across the crypto landscape. Investors take advantage by lending out their stablecoins and collecting sizable yields.
Onramp to Participate in Decentralized Finance (DeFi)
Stablecoins provide the primary gateway to utilize decentralized finance (DeFi) applications. DeFi protocols like lending, borrowing, trading, insurance, and more are built on blockchain networks like Ethereum. To interact with these dApps, users need a cryptocurrency native to that network. Stablecoins allow anyone to gain access to DeFi apps without exposure to volatility from regular cryptos like ETH.
With assets pegged to USD, users can minimize risk while unlocking innovative DeFi services: earn interest on deposits through lending platforms, take out crypto collateralized loans, trade tokens on DEXs, invest in liquidity pools, purchase NFTs, and more. Stablecoins enable broader DeFi participation without converting funds into volatile assets like ETH.
Make Payments with Cryptocurrency Debit Cards
Cryptocurrency debit cards allow users to spend stables and other cryptos anywhere major credit cards are accepted. The cards automatically convert crypto to fiat and settle the transaction. Users fund their card wallet by depositing stables like USDC, then simply swipe to spend.
Not only does this provide a real world use case for stables as money, it offers advantages over regular debit cards. Users earn crypto rewards on card spending, can send funds to anyone worldwide, and don’t need to maintain a high fiat balance for payments. Stablecoins bridge the gap between digital and real world spending.
Lend to Generate Yield
Those holding stablecoins can also earn interest by lending out their stables to borrowers. Centralized lending platforms like BlockFi and Celsius have institutional borrowers like hedge funds who pay double digit rates to borrow stables. By lending stables, retail lenders earn yields in the process.
Borrowers use stablecoins for trading, arbitrage across exchanges, or as working capital for their crypto businesses. Their demand drives up interest rates. Lenders act as liquidity providers, earning attractive yields on their lent stablecoins while borrowers pay for the liquidity needed to fund their activities. It’s a win-win for both sides.
Store Value Long Term
Although less common, some see potential in certain stablecoins as a long term store of value. Stablecoins pegged to gold like Digix (DGX) could preserve wealth over an extended time horizon compared to fiat currencies which inflate over time. Creative “algorithmic stables” like TerraUSD (UST) aim to be more dependable stores of value using code rather than collateral.
While they lack the upside of stocks or crypto, for conservative investors who prioritize capital preservation, select stables may offer appeal versus keeping all wealth in dollars vulnerable to inflation. This is still an emerging niche use case but shows the breadth of stablecoin applications.
Common Criticisms Against Stablecoins
Despite their many legitimate uses, stablecoins also face their share of criticism and skepticism. Here are some of the most common arguments against stablecoins:
Lack of Transparency Around Reserves
The biggest concern is whether popular stablecoins like Tether and USDC actually hold sufficient dollar reserves to back the amount of tokens in circulation. These stables are supposed to maintain 1:1 dollar collateral, but some fear reserves may be inadequate or the company dishonest about balances.
Tether for instance once claimed all USDT was backed by dollars, but later admitted only a portion was. They have since improved but doubts still remain. Better auditing and transparency around reserves can improve trust in backed stablecoins.
Regulatory Risk
Stablecoins occupy a gray area in many jurisdictions, lacking clear regulatory guidelines. Governments are still evaluating how to best regulate them. As regulations evolve, it could impact certain stablecoins’ viability if deemed securities akin to unregistered bonds. Concerns around proper KYC and AML procedures also exist. Tighter regulations may be imposed that exclude some stables.
Until regulatory frameworks are formalized, stablecoins carry uncertainty around what type of compliance will be expected and whether all can meet requirements. This poses a degree of regulatory risk to the asset class.
Hack and Failure Risk
Like any cryptocurrency, stablecoins are only as secure as their underlying code. Bugs can be exploited, and crypto companies have lost funds before. A major protocol failure or hack of a popular stablecoin could undermine confidence and roil the broader market given stables importance to crypto trading.
Stablecoin smart contracts and collateralization models should be thoroughly audited and tested to ensure they behave as expected during all market conditions. Robust security infrastructure and processes can help minimize potential hacking or failure risk events.
Centralization Concerns
Major stablecoins are produced by private centralized companies, leading to criticism around centralized control. Tether for example has huge sway over a multi-billion dollar asset class. Users must trust the issuer, which conflicts with cryptocurrency’s decentralized ethos.
However, newer decentralized algorithms like DAI offer a stablecoin without central control. Other models like indexed stables are emerging that aim to be decentralized and transparent. Over time, stablecoins may transition to more decentralized architecture.
Lost Opportunity Cost
When invested in stablecoins, investors lose upside potential compared to assets like stocks or regular cryptocurrencies. While they preserve capital, stables won’t benefit from rising markets. Holding stablecoins passing up gains elsewhere is their primary “cost”.
However, stables still offer favorable risk-adjusted returns for more risk averse investors. The lost potential upside is exchanged for lower volatility and consistent stable value. Stables should be judged on their ability to execute their purpose as stable assets, not maximize gains.
Examples of Top Stablecoins
There are now hundreds of stablecoins across different blockchains, collateral models, and structures. Here are some of the most popular and important stablecoins in use today:
Tether (USDT)
– Launched in 2014, Tether is the first and most widely used stablecoin with a market cap over $70 billion. It maintains peg to USD through reserves of cash, commercial paper, and other assets. Long the dominant stablecoin, Tether provides critical liquidity across the crypto landscape. It’s widely criticized for lack of transparency but so far maintains its peg.
USD Coin (USDC)
– Created by Circle and Coinbase, USDC has quickly risen to prominence as the 2nd largest stablecoin at $50 billion market cap. It’s popular for transparently holding USD reserves and being fully backed 1:1 with cash and equivalents. Regarded as a trusted and regulatory compliant option.
Dai (DAI)
– DAI pioneered the “decentralized stablecoin” concept without centralized control. Using collateral and arbitrage incentives, it maintains soft peg to $1. Slower adoption but demonstration of stability without centralization makes DAI a top contender.
Binance USD (BUSD)
– Launched in 2019 by Binance crypto exchange, BUSD aims to rival fellow stables USDT and USDC in trade volume. It’s fully backed by USD reserves. Growing popularity due to Binance’s massive user base makes BUSD a rising stablecoin.
TerraUSD (UST)
– TerraUSD follows a new “algorithmic stablecoin” model that programmatically adjusts supply to preserve peg. Backed by LUNA token instead of fiat reserves. Promises stability without central control, but remains unproven long-term. Pioneering concept.
Pax Dollar (USDP)
– Issued by Paxos Trust company, USDP holds 1:1 dollar collateral in US banks. Fast growing with monthly attestations proving reserves. Used by PayPal for crypto transactions. Regulatory compliant stablecoin gaining adoption.
Conclusion
In summary, stablecoins offer investors a way to access the world of cryptocurrency and decentralized finance while reducing exposure to volatility. Their stabilized value provides an onramp for crypto spending, trading, earning yields, and more use cases. While criticisms exist around transparency and centralization, demand for stablecoins continues to rise. They provide the liquidity and price stability desired by many investors and institutions in the maturing crypto economy. For sustainable mainstream adoption, stablecoins will only grow in importance over the coming years.