Stablecoins are a type of cryptocurrency pegged to an asset like the US dollar that doesn’t change much in value.
The majority of the dozens of stablecoins currently in existence use the dollar as their benchmark asset, but many are also pegged to other fiat currencies issued by governments such as the euro and the yen. As a result, the price of stablecoins is supposed to fluctuate very little, unlike high-profile cryptocurrencies like bitcoin and ethereum which are prone to sudden ups and downs.
The first stablecoin, created in 2014, was Tether, which many other stablecoins are modeled after. Users receive one token for every dollar they deposit. In theory, the tokens can then be converted back to the original currency at any time, including at a one-to-one exchange rate.
As of May 11, 2022, about $83 billion in Tether was outstanding, or just under half of the $172 billion market cap of all stablecoins worldwide. The second largest is known as USD Coin, with a market cap of approximately $49 billion.
Why Stable Coins Matter
Originally, stablecoins were mainly used to buy other cryptocurrencies, such as bitcoin, as many cryptocurrency exchanges did not have access to traditional banking. They are more useful than country-issued currencies because you can use them 24 hours a day, seven days a week, anywhere in the world – without depending on banks. Transfers take a few seconds to complete.
Another useful feature of stablecoins is that they can work with so-called smart contracts on blockchains, which, unlike conventional contracts, require no legal authority to run. The code in the software automatically determines the terms of the agreement and how and when money is transferred. This makes stablecoins programmable in ways that dollars cannot.
Smart contracts have led to the use of stablecoins not only for seamless trading, but also for loans, payments, insurance, forecasting markets and decentralized autonomous organizations – companies that operate with limited human intervention.
Together, these software-based financial services are known as decentralized finance or DeFi.
Proponents believe that moving money through stablecoins is faster, cheaper and easier to integrate into software compared to fiat currency.
Others say the lack of regulation poses major risks to the financial system. In a recent paper, economists Gary B. Gorton and Jeffery Zhang draw an analogy to the mid-19th century era when banks issued their own private currencies. They say stablecoins can lead to the same problems as they did back then, when there were frequent runs because people couldn’t agree on the value of privately issued currency.
A reminder of those risks came in May 2022 when a so-called algorithmic stablecoin known as TerraUSD, or UST, depreciated. Algorithmic stablecoins use a complex system of burning, or creating tokens for profit, to maintain their peg.
As a result of these issues, regulators have recently become more interested in them.
Stephen McKeon, associate professor of finance, University of Oregon
This article is republished from The Conversation under a Creative Commons license. Read the original article.