The price of bitcoin, ether and other popular cryptocurrencies collapsed this week as investors trimmed their losses and sought refuge in less volatile assets. A catalyst forare growing concerns about so-called stablecoins, another kind of cryptocurrency that should protect buyers from the sharp swings typical of virtual money.
Read on to learn more about stablecoins.
What are stable coins?
Stablecoins are cryptos linked to a reserve asset such as a currency (such as the dollar or euro) or a commodity (such as gold, oil or real estate). Backing by other assets makes the value of stablecoins less prone to roller coaster changes in price, hence the name.
For example, stablecoin PAXG, or Pax Gold, is pegged to gold prices, while terraUSD is pegged to the US dollar. According to the Blockchain Council, there are about 200 types of stablecoins worldwide. As of Friday, the three largest stablecoins were tied by market value at $78.6 billion, USD coin ($49.9 billion) and Binance USD ($17.2 billion).
As of Friday, the total market value of stablecoins was $163 billion, according to CoinMarketCap.
What are stablecoins used for?
Investors use stablecoins to protect their money against:associated with other cryptocurrencies. In fact, stablecoins are meant to serve as the tokenized version of fiat currency or other fixed-value real-world assets.
Decentralized financial platforms such as BlockFi and Celsius use stablecoins to lend crypto to their customers. The reason they use stablecoins is that the value of the collateralized tokens or currency is unlikely to change drastically between a customer is approved for a loan and the cryptocurrency lands in the individual’s digital wallet.
More advanced crypto investors can use stablecoins to avoid paying transaction fees on crypto exchanges such as Binance and Coinbase, many of which do not charge a fee to exchange currencies for stablecoins.
Are stablecoins really stable?
Crypto makers have marketed stablecoins as safe and predictable, but as investors discovered this month, that’s not always the case.
For example, although it is pegged to the US dollar, the stablecoin terraUSD fell to 77 cents this week. Luna, another dollar-backed stablecoin, dropped below $1 Wednesday night; Tether fell to 95 cents on Thursday.
Some investors were so outraged by the devaluation of their stablecoins that they filed a lawsuit against Coinbase on Thursday. The lawsuit revolves around the stablecoin GYEN, which is pegged to the Japanese yen.
“Investors placed orders assuming that the coin’s value, as advertised, was equal to the yen, but the tokens they bought were worth up to seven times the yen,” the lawsuit said. “Just as suddenly, the GYEN’s value plunged back into the pin — by 80 percent in one day.”
Why do some stablecoins fall?
Stablecoins have fallen victim towhich went into high gear shortly after by half a percentage point. Higher interest rates, coupled with rising inflation and supply chain problems, have led investors to fear that the US economy will come under pressure for the foreseeable future.
Due to this increasing economic uncertainty, many investors have shifted their portfolios away from riskier assets, including stablecoins and other cryptos. The price of most cryptocurrencies fell from 5% to 85% in the past week, according to data from CoinMarketCap.
What are government regulators concerned about?
US lawmakers are thinking about ways to regulate the burgeoning cryptocurrency market, and stablecoins have been at the center of those discussions.
Stablecoins, in particular, need police scrutiny because of their burgeoning popularity and because “they are backed by assets that can lose value or become illiquid during stress,” making them “vulnerable to runs,” according to a Federal Reserve report released Monday. A ‘run’ in the banking world is when all or most account holders withdraw their funds at the same time because they believe the institution will not be around for much longer.
The Fed report also noted that the stablecoin sector is “highly concentrated with the three largest stablecoin issuers – Tether, USD Coin and Binance USD – making up more than 80% of the total market value.”
US Treasury Secretary Janet Yellen this week reiterated the call for stablecoin regulation, noting how quickly a price drop could affect investors.
“A stablecoin known asin value,” she told a Senate banking committee on Tuesday. “I think that just illustrates that this is a fast-growing product and there are risks to financial stability and we need an appropriate framework.”