When it comes to investing in cryptocurrency, many people opt for alternative coins that are not as volatile as Bitcoin and Ethereum. Therefore, stablecoins often take the spotlight as a less risky option in the crypto market. However, not even stablecoins are a risk-free safe haven hedge against inflation. Some even speculate that the downfall of one major stablecoin, Tether, could send shockwaves through the entire market. However, let’s take a look at what keeps stablecoins stable, and what the subsequent risks are.
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What Keeps Stablecoins Stable?
Stablecoins are digital tokens pegged to a reserve asset like gold, fiat currency, cryptos, or an algorithm. These were created to provide a digital option that is less volatile than cryptocurrencies, which makes stablecoins better for everyday commerce. This is the case unless the asset pegged to the stablecoin moves. Usually, stablecoins are tied to currency because fiat serves as collateral for the stablecoin. Other stablecoins might represent wealth in gold. PAXG and Goldcoin are two examples.
Recently, the Office of the Comptroller of the Currency announced that banks can now use stablecoins. This establishes stablecoins as an alternative to traditional currencies. Consequently, investors might find it a more trustworthy means of international exchange. Additional global support for stable coins also grows as a result of the pandemic. But what should investors know before they jump into the stablecoin market?
The Pros and Cons of Stablecoins
Stablecoins are great for several reasons. The top three benefits of stablecoins are:
- They can be used internationally without exchange fees.
- Transactions are much faster than Bitcoin, Ethereum, and other cryptocurrencies.
- Transactions are also on a public ledger that anyone can review, with your identity remaining anonymous.
Many people currently buy stablecoins to set up a hedge against inflation. But if your stablecoin is backed by fiat currency, keep in mind that it does not grow as quickly. Additionally, inflation will also affect stablecoins. Do not forget, newly-sworn-in US President Biden seeks to provide more stimulus. The Federal Reserve does this by printing more money. So, it is worth noting that stablecoins pegged to fiat currency probably will not protect against inflation.
But perhaps the biggest risk when it comes to stablecoins is whether or not you can trust the company that maintains the crypto. If they are not transparent about where the reserves are, whatever the stablecoin is pegged to could be worth much less. Tether (USDT) is one current company that exemplifies this. You can read more about it below. Right now, let's review some of the top stablecoins because what backs stablecoins varies.
What Are the Top Stablecoins?
Recently, stablecoins reached a value of over $30 billion. Stablecoins are appealing because they can apply to everyday commerce internationally. Here’s why investors like stablecoins: if you buy a coffee for $5 one day, and then the price of Bitcoin crashes, then you just spent significantly more than $5! On the other hand, stablecoins allow a certain degree of protection over this volatility. Let’s take a look at some of the most recognized stablecoins.
List of Stablecoins
The Paxos Standard token (PAX), is one of the top stablecoins for its trustworthiness. According to the website, PAX is “fully collateralized 1:1 by the US dollar.” The actual currency is stored in government-controlled treasuries, and it operates on the Ethereum blockchain. Furthermore, the NY State Department of Financial Services both approves of and regulates it. What makes PAX so useful is that it can be exchanged anywhere in the world, instantly. Paxos is also trying to become a national bank, and it created PAXG in 2019. PAXG is a stablecoin backed by gold that is stored in vaults in London. NY also approves of and regulates this gold-backed stablecoin. You can exchange this for physical gold as well and have the best of both worlds cryptos and precious metals.
Circle and Coinbase launched the USD Coin (USDC) in 2018. US currency connects to this stablecoin, just like Tether. It is the second-largest stablecoin by its market capitalization, which is over $5 billion. The firms controlling USDC are regulatorily compliant, and a major accounting firm verifies USDC.
Finally, we have Binance/Paxos stablecoin, BUSD. The NYS Department of Financial Services also approves this USD-backed stablecoin. Basically, BUSD is specific to trading on Binance, and it is also an Ethereum-powered asset tied to the dollar. You can redeem BUSD for cash through Paxos, but the actual fiat is stored in FDIC-insured banks in the US. The key difference between BUSD and PAX is that there are additional bonuses to owning BUSD. You are able to earn on staked BUSD, meaning the more funds you secure over time, the more interest you can accrue.
Stablecoins: Current Litigation
Why is Tether Being Sued? What Does it Mean for the Crypto Market?
Tether, or USDT, is one of the first-ever stablecoins. Tether launched in 2014, and it is backed by the US dollar. Over 94% of all stable coin trading volumes uses Tether as a decentralized dollar. In other words,Tether allows users to keep an eye on their investments since they can convert it to other stablecoins and cryptos. This bypasses the need for Bitcoin, making Tether one of the most useful stablecoins on the market.
Unfortunately, Tether is in a legal battle with the NY Attorney General who wants to audit its financial documents. These documents can illuminate Tether’s relationship with Bitfinex, which is its parent company. Tether is yet to open up to a full audit of its reserves. A recent discovery showed that Tether only had about 80-90 cents to a dollar for what investors actually put in. Therefore, Tether is not actually 1:1 with the US dollar as it advertises, which might mean investors will abandon Tether before it completely falls apart. This does not bode well for the Tether investor since it is still the world’s most popular stablecoin. Some speculate that if Tether falls apart, PAX might take its place since it is more trustworthy.
If this investigation wipes out Tether, this might stir up distrust in the crypto market. Therefore, investors may scramble to find other places to invest in their inflation hedge. A recent article by Anton Wahlman noted that significant Bitcoin demand comes from Tether. Therefore, if Tether “unwinds,” it might mean an outpouring of crypto investors from Bitcoin as well. They will then scramble to find other safe-haven assets, which might mean precious metals. The opportunity to buy gold with Bitcoin is entirely possible and might be the route many go in order to quickly transition into safer hedges.
Stablecoins: Are They Worth It?
Stablecoins can be a great alternative to the traditionally volatile Bitcoin and Ethereum, as well as an alternative to fiat currency. But when it comes down to creating your safe haven hedge portfolio, diversification is key—just like your stocks. If any stablecoins fail entirely at this tumultuous time, it could spark the desire to escape to other commodities, stablecoins, or cryptos. Know the risks of all your options before you buy.
Therefore, avoid relying on one asset alone. Therefore, if stablecoins are where you decide to go, consider also investing in physical assets like gold and silver. You can even enjoy both easily with PAXG and other gold-backed tokens. However, PAXG is the most regulated that also allows you to trade in your stablecoins for gold.