In June 2020, Grameen Foundation, a nonprofit, sent emergency cash assistance to entrepreneurs in the Philippines. During community-wide lockdowns, it was difficult for the recipients to claim cash, as restrictions on people’s movement made it challenging to make withdrawals at banks and remittance centers. The foundation instead used Celo stablecoins to send almost $160,000 worth of financial aid to at least 730 entrepreneurs. Workers and their families across the globe could use digital wallets to receive stablecoins from anywhere in the world almost instantly — with low fees and without price volatility.
In the event of a big crash, there is no collateral to liquidate the coin back into. This is the most decentralized form of stablecoin as it isn’t collateralized to any other asset. As demand increases, new stablecoins are created to reduce the price back to the normal level.
Why Use Stablecoins?
Commodity-collateralized stablecoins are backed by other kinds of interchangeable assets. However, there are also stablecoins backed by oil, real estate, and various precious metals. Finally, even where stablecoins may offer the potential to streamline financial services, they will likely face pushback from local governments. For instance, in a country with high inflation rates, the government may look to block stablecoins pegged to foreign currencies in order to protect demand for the local currency.
- Finally, even where stablecoins may offer the potential to streamline financial services, they will likely face pushback from local governments.
- For businesses, Chai has an API to let e-commerce sites accept different payment options.
- We also analyze the different types of stablecoins, as well as their applications and limitations.
- For example, $100 (roughly £75) worth of jGBP would be equivalent to 100 USDC.
- But the use of stablecoins allows exchanges to get around this problem and offer crypto-fiat trading pairs, by simply using a USD-backed stablecoin instead of actual dollars.
- An investigation by the Commodity Futures Trading Commission found that from 2016 to 2019, Tether falsely claimed to have held an equivalent amount of fiat currency for every single USDT.
While it is impossible to predict what the future has in store in the constantly changing world of blockchain, stablecoins could help bring cryptocurrencies further into the mainstream. For instance, coin holders could speculate on an issuer’s intention to change or rebalance its portfolio of reserve assets. The holders might buy and sell different assets while also making stablecoin purchases or redemptions in order to front-run their purchases. However, non-collateralized stablecoins require continual growth to be successful.
SwissRealCoin is another example, which is backed by a portfolio of Swiss real estate. The same idea can apply for automatic payments of loans or monthly subscriptions like gym memberships.
Tech Markets Improving Value
By nature of being more regulated, stablecoins may also have less liquidity than regular cryptocurrencies. This is the main use case behind the Novi crypto wallet by Meta , which was launched with a pilot program for transferring money between users in the US and Guatemala. Novi currently uses PAX, but the company maintains that it will launch its own stablecoin, Diem, once regulators approve it. Cryptocurrency offers the potential for fast transactions and low fees, but there’s still the problem that a cryptocurrency like bitcoin could fluctuate wildly in value overnight. Crypto cards can also serve as a channel for stablecoins to enter mainstream spending. For example, both Visa and Mastercard have launched payment cards that allow transactions in USDC.
The widespread use of stablecoins in payment platforms also presents a systemic risk, according to the same report. The novel operational risks tied to the validation and confirmation of stablecoin transactions can interfere with payment systems. If millions of users can’t access money in their e-wallets and businesses can’t receive payments, economic activity would be greatly disrupted.
In the process, they mint more tokens, reducing their value and making a bank run more likely. This, in turn, causes the stablecoin’s value to drop, leading to a cycle known as the “death spiral.” When the Iron stablecoin and its Titan token fell victim to this spiral, the token’s value fell to almost zero. Remember, the US dollar used to be backed by gold, but that ended decades ago, and dollars are still perfectly stable because people believe in their value. To reduce price volatility risks, these stablecoins are often over-collateralized so they can absorb price fluctuations in the collateral. In theory, this allows crypto-backed stablecoins to be more decentralized than their fiat-backed counterparts since everything is conducted using blockchain tech. Stablecoins, on the other hand, aim to gain the potential benefits of cryptocurrencies — such as transparency, security, immutability, and decentralized control — without losing the guarantees and stability that come with using fiat currency.
However, it received so much regulatory blowback that the project’s management dropped its multi-currency aim, distanced itself from Facebook, and rebranded altogether. To this day, the network is still struggling to get regulators to sanction its own stablecoin. For example, an employer could set up a smart contract that automatically transfers stablecoins to their employees at the end of each month. Few cryptocurrency exchanges currently support fiat currencies due to strict regulations. But the use of stablecoins allows exchanges to get around this problem and offer crypto-fiat trading pairs, by simply using a USD-backed stablecoin instead of actual dollars.
Widespread adoption of digital currencies more broadly will depend on whether or not crypto can find a role for everyday users and use cases. In response to the impending regulations, Rune Christensen, founder of MakerDAO, is preparing for “the worst.” On the other hand, Jeremy Allaire, the CEO of USDC backer Circle, says he welcomes plans to regulate stablecoin issuers as banks. Projects like these will shed light on how much traction stablecoins can gain with the public and on how cost-efficient this use case can be in the real world. Banks themselves could also lead the adoption of stablecoins for this purpose. Shinhan Bank in South Korea and Standard Bank in South Africa are testing out a proof-of-concept for using stablecoins for cross-border remittances.
With billions being transferred in global remittances every year, this is a massive use case for stablecoins. Smart contracts are self-executing contracts that exist on a blockchain network, without requiring any third party or central authority to enact them. These automatic transactions can be traceable, transparent, and irreversible, making them well-suited for salary and loan payments, rent payments, and subscriptions. Such is the case with the Pax Dollar and Gemini Dollar , two USD-backed stablecoins that are regulated by the New York State Department of Financial Services. The issuers of the two coins publish monthly reserve audits that are verified by independent accounting firms.
A recent US Treasury report on stablecoins discussed the systemic risk that a single stablecoin could pose if it becomes widely adopted. The risk is especially high with centralized coins, such as those backed by fiat and issued by private organizations, as economic power would be disproportionately concentrated on a single entity. Already, financial services players — from bank incumbent JPMorgan to payments network Visa — are giving nods to stablecoin technology through partnerships and internal R&D. MakerDAO appears to have learned the perils of relying solely on volatile crypto assets.
It’s easy to understand for anyone new to cryptocurrencies — which, in turn, can allow for more widespread adoption. When someone wants to redeem cash with their coins, the entity that manages the stablecoin will take out the amount of fiat from their reserve and it will be sent to the person’s bank account. The equivalent stablecoins are then “burned” or permanently removed from circulation. Initially, early crypto holders used stablecoins as a safe haven in the event of a market decline or crash. If the price of bitcoin began to drop rapidly, a holder could convert their bitcoin to a stablecoin within a matter of minutes on a single platform, avoiding potentially massive losses. The ease and speed of transacting with stablecoins is conducive to speculative trading of digital assets, which can threaten market integrity and investor protection, according to the US Treasury Department.
For businesses, Chai has an API to let e-commerce sites accept different payment options. In both cases, currency is converted into Terra, which is transferred to the recipient on the blockchain and converted back into fiat. Making a stablecoin useful in an everyday sense would help shield it from such a scenario as demand for it would be less likely to plummet quickly. This is the premise of Terra, an algorithmic stablecoin with Luna tokens as their reserve asset. Confidence in the stablecoin has since rebounded — Dai’s market cap increased by 800% from September 2020 to September 2021, and it remains one of the top five most popular stablecoins globally. Stablecoins are not subject to the extreme price volatility that many other cryptocurrencies are affected by.
Some stablecoin issuers have submitted to strict regulatory oversight to help assure their customers of their cash reserves. In this explainer, we dive into stablecoins, from what they are to why they’re emerging as a disruptor across the crypto space to why pressure is mounting to tighten the regulation of these digital coins. We also analyze the different types of stablecoins, as well as their applications and limitations. This reflects the momentum driving the so-called “stablecoin invasion.” There are now more than 200 stablecoins globally, comprising a market that’s worth nearly $130B. Additionally, two USD-backed stablecoins, the Paxos Standard and Gemini Dollar , have been approved and regulated by the New York State Department of Financial Services. If you ever wanted to get your real bars of gold, for example, it could take months and an expensive trip to a physical vault.
For example, to get $500 worth of stablecoins, you would need to deposit $1,000 worth of Ether . In this scenario, the stablecoins are now 200% collateralized, and even in the event of a 25% price drop, the $500 worth of stablecoins are collateralized by $750 worth of ETH. Stablecoins may be misused to break laws on anti-money laundering and countering the financing of terrorism . A report by Chain Analysis reveals that much of the cryptocurrency used for illicit activities goes to scams and the darknet market.
It is now diversifying its collateral base to include stablecoins like USDC and “real-world assets.” For example, French bank Société Générale-Forge has proposed backing Dai with $40M in bonds. Holders of commodity-backed stablecoins are essentially exposed to the value of a real-world asset. These assets have the potential to appreciate — or depreciate What is a stablecoin and how it works — in value over time, which can affect the incentives for trading these coins. Commodity-backed stablecoins are sometimes marketed as a way to open up certain asset classes, like real estate, to smaller investors. Fiat-collateralized stablecoins are pretty much the simplest structure a stablecoin can have, and simplicity has big advantages.
What Are Stablecoins?
In today’s world, many migrant workers rely on businesses like Western Union to send money back to their families and loved ones. This can be a slow and costly process, where families end up losing a big chunk of their funds to high fees. Well-designed stablecoins have the potential to be used just like any other currency for commerce. These types of coins use an algorithmically governed approach to control the stablecoin supply. Crypto-backed stablecoins are a relatively complex form of stablecoin and have not gained as much traction as other approaches. In fact, the two coins have captured more than two-thirds of the stablecoin market, with USDC steadily chipping away at USDT’s market share.
A stablecoin is typically a cryptocurrency that is collateralized by the value of an underlying asset. What that underlying asset may be varies from coin to coin, which we’ll dive into later in this piece. And yet — despite being the purported answer to cryptocurrencies’ volatility — stablecoins are now under close scrutiny, with regulators in the US and China saying they pose a serious risk to financial systems. Financial services incumbents are also eyeing the opportunity — JPMorgan Chase, for example, has piloted and launched a stablecoin, JPM Coin, for its corporate clients.
Risks And Regulations
The creators of DGX claim they have “democratized access to gold.” DGX holders may even redeem their coins for physical gold — they just have to go to the vault in Singapore to do so. In 2010, for example, a programmer purchased pizza for 10,000 bitcoins — worth roughly $688M at bitcoin’s peak in November 2021. On the flip side, any merchant that accepted those bitcoins at that peak price would have lost more than $200M by the end of the year.
Market Trend Report: Integrated Point
Being pegged to other cryptocurrencies makes them much more vulnerable to price instability in comparison to fiat- or commodity-backed stablecoins. In the event of a fiat currency crashing in value, local citizens could quickly exchange their crashing currency for relatively safe USD-backed, EUR-backed, or even gold-backed stablecoins, https://xcritical.com/ thus protecting them from further drops in value. Stablecoins could also find applications for overseas money transfers since there doesn’t have to be any conversion of different fiat currencies. A person in India could receive USD-backed stablecoins without converting them into rupees and losing a percentage to fees.
What Are Stablecoins?
Without this option, the crypto holder would have had to move their capital back into a fiat currency. However, many cryptocurrency exchanges either do not allow fiat on the platform or take a large fee from the transfer into fiat. Think about “Black Wednesday” in the UK in 1992, or the 1998 Ruble crisis that occurred in Russia. If such an event occurs to the fiat a stablecoin is pegged to, it would be disastrous for that stablecoin as well. To solve this trust problem, stablecoins could adopt approaches like providing regular audits from third parties to bolster transparency.
Why Use Stablecoins?
Unlike traditional forex that opens on specified market hours and can take a while to settle transactions, Waves.Exchange’s platform is open 24/7 and promises instant swaps. Use cases drive adoption, and Terraform Labs has built a lot of utility into the Terra ecosystem. Chai, its payment system, reportedly processes $1B+ per year and had about 2.5M users in 2020. Created by MakerDAO, Dai is a stablecoin that has a face value pegged to USD, but was initially designed to be backed by ETH that is locked up in smart contracts. Digix Gold , for example, is an ERC-20 token backed by physical gold, where 1 DGX represents 1 gram of gold.
Meanwhile, a survey of central banks in January 2021 found that two-thirds of respondents are actively researching the potential impact of stablecoins on financial stability. The Financial Action Task Force has also recommended the implementation of its revised AML/CFT standards to stablecoin arrangements. Meanwhile, the European Union has proposed a law meant to ensure full traceability of cryptoasset transactions. The law will require companies handling cryptoassets to obtain customer details, such as their full name, date of birth, and account number. They are tied to the health of a particular cryptocurrency , which means if that crypto takes a deep nosedive, the stablecoin ultimately will as well. In the event of a price crash, they will be auto-liquidated into the underlying crypto asset.
Meanwhile, China has rolled out large-scale trials of its digital yuan, also called the e-CNY. As of October 2021, around 140M people had made e-CNY transactions worth a total of 62B yuan ($9.7B). By issuing its own CBDC, the country hopes to increase usage of the yuan globally and to lower the cost of cross-border payments. This allows Chai to offer lower processing fees compared to some traditional payment processing systems. It also means that consumers might not even know they used a stablecoin — let alone need to understand how it works — when paying for a cup of coffee or an online purchase.