An ever-growing segment of the crypto ecosystem, stablecoins are a cost-effective and practical way for crypto investors to transact in cryptocurrency.
A government committee in the U.S. is looking into regulating stablecoins, which are different from other more volatile types of cryptocurrencies. The value of Bitcoin and Ethereum may fluctuate daily and even hour to hour, but stablecoins are pegged to assets that don't fluctuate as much, like the U.S. dollar or euro. Stablecoins may someday serve as actual currency, so U.S. government officials fear stabilitycoins could pose risks for consumers and financial markets.
What should every investor be aware of about stablecoins?
What are stablecoins?
Cryptocurrencies with a stable price are called stablecoins. Their values are pegged to the value of another commodity, currency, or financial instrument; as an alternative to Bitcoin and other cryptocurrencies that are volatile, stablecoins aim to provide a stable choice for investors. Like other cryptocurrencies, investments have been less suitable for wide use in everyday transactions because of their high volatility.
Cryptocurrencies like Bitcoin are popular, but their prices and exchange rates are highly volatile. For instance, during the first two months of 2021, Bitcoin's price soared from nearly $4,000 to almost $65,000, falling almost 50% within two months. Cryptocurrencies can also go through wild swings intraday; they often move more than 10% within a few hours.
Traders can benefit from all this volatility, but buyers and sellers are at risk of risky speculation due to this volatility. Cryptocurrency investors who hold their coins for long-term appreciation don't want to go down in history for paying 10,000 Bitcoins for two pizzas. In the meantime, merchants want to avoid losing money when cryptocurrency prices plunge after they receive payment.
The value of an unofficial currency must be relatively stable, ensuring that those who accept it will have the ability to retain their purchasing power over time. In forex trading, even 1% daily movements are unusual among traditional fiat currencies.
This problem is addressed by stablecoins, which promise to keep the cryptocurrency's value steady by utilizing several methods.
What is the best way to use stablecoins?
Using stablecoins, people can easily transact with cryptocurrency that serves as an investment, such as Bitcoin or Ethereum. These assets serve as a bridge between volatile cryptocurrencies and stable assets in the real world, such as fiat money. All your transactions can be maintained within crypto exchanges when you trade with stablecoins rather than U.S. dollars, which will save you from many exchange fees.
For example, suppose you have some Ethereum and some Solana and would like to buy more Solana with your Ethereum. Using stablecoins, such as USDT, you can swap your Ethereum for U.S. dollars and then use the U.S. dollars to buy more Solana. Due to their separate blockchains, Solana and Ethereum do not communicate with one another very well. While volatile periods in the market can affect the value of your crypto, stablecoins can reduce your fees and protect your investment as a middle man.
Yang notes that sometimes the conversion from Solana to Ethereum is a little bit more challenging since they are on two different levels. However, stablecoin acts as the common denominator.
In spite of the fact that stablecoins are sometimes used by advanced crypto traders for more complex investments like staking and lending, most beginners use stablecoins in order to avoid trading fees. In many crypto exchanges, stablecoins can be exchanged for U.S. dollars without fees. The USD Coin is not subject to any fees when transferred between Coinbase and a U.S. dollar, for example.
In addition to international remittances, stablecoins can be used for fund transfers across international borders, although this may be risky since there is little regulation. Especially during times of economic hardship, stablecoins may not be as stable as they are promoted to be because they are made up of private money, not government money. Fraud and security concerns are also present. Stablecoins don't guarantee that you'll get your money back if you put it in them.
Is it possible to invest in stablecoins?
There is a niche use for stablecoins in the crypto world - and they don't make good investments. The use of this stablecoin is better suited for digital transactions and the conversion of digital assets into and out of "real" money.
In the short term, trading coins for stablecoins can be quicker, easier, and cheaper than exchanging actual coins for dollars in your bank account. Because crypto trading can be volatile, it can be super convenient to exchange your crypto coins for stablecoins. The Bitcoin you own could, for example, be converted into USDT, which would remain on the exchange you're trading on and hold its value.
Once you've acquired stablecoins, you can exchange them for other currencies. Changing your Bitcoin directly to U.S. dollars would take longer, taking it out of the crypto exchange and out of your banking account. In order to avoid losing money when switching between currencies, it is best not to switch between two different currencies at once.
Are there any drawbacks to stablecoins?
It would help if you kept in mind that stablecoins have some drawbacks. Unlike other cryptocurrencies, stablecoins tend to have different pain points due to the way they are usually set up. Banks and other third parties sometimes store reserve funds with them, resulting in counterparty risk. Ultimately, it comes down to this question: Make the claims of collateral hold up? The USDT token and dollar backing of Tether, for example, has been a frequent question posed to the company. There is a possibility that the reserves backing a stablecoin would not be sufficient to redeem every unit, which might shake public confidence.
In the past, users trusted intermediary companies with their money. Cryptocurrencies replaced those intermediaries. Typically, intermediaries can stop a transaction from occurring by virtue of their control over the money. It is possible to prevent transactions with some stablecoins. If coins are used in an unlawful manner, the USD coin has open back doors that can stop payments. Law enforcement compelled Circle, part of the USDC team, to freeze $100,000 of the stablecoin in July 2020.