What are they?
The easiest (but not so technically correct) way to think of a stablecoin is a digital dollar. They’re collateralized and pegged against a normal fiat currency. The biggest of the bunch is Tether ($USDT.X). One USDT is worth one USD. So for every USDT that exists, it is backed by one USD – supposedly. There are issues and controversies with Tether regarding transparency and accounting practices, but that’s for another article.
What Are They Used For?
Simple answer: Speculation, trading, and more speculation.
You can think of Tether as the Bitcoin of stablecoins. Most of the volume traded in cryptocurrencies is with Tether, so it’s extremely important to the overall market. But Tether isn’t the only stablecoin. A US-based stablecoin, USD Coin ($USDC.X), has slowly gained more traction and use and is more trusted due to U.S. laws and regulations. Even though USDC is the second most popular and second highest market cap stablecoin, it dwarfs USDT in its use.
USDT has a market cap of $68 billion compared to USDC’s $46.7 billion. Comparatively, the market caps are not far off (compared to other stablecoins) between USDT and USDC. However, when it comes to traded volume, the gap is massive. USDT’s average 24-hour volume is $42 billion versus USDC’s $3.7 billion.
Stablecoins are becoming increasingly useful as a form of payment for goods and services – often eliminating the transfer and/or conversion rates that banks or other payment services may charge.
What About Algorithmic Stablecoins?
Algorithmic stablecoins have never worked. Ever. Maybe we’ll have to edit this in the future, but as of October 2022, all attempts to make an algorithmic stablecoin work have failed.
One of the biggest catastrophes in cryptocurrency history occurred in 2022 with the collapse of Terra’s algorithmic stablecoin, TerraUSD ($UST.X). UST was pegged against the USD BUT was not backed not by USD like regular stablecoins. Instead, UST was backed by Bitcoin reserves, Luna ($LUNA.X), Avalance ($AVAX.X), and other crypto assets. A fancy schmancy algorithm was supposed to maintain the 1 UST = $1 USD ratio – until it didn’t.
UST collapsed, taking LUNA with it. And a cascade of horribleness occurred with crypto exchanges Voyager ($VGX.X), Celsius ($CEL.X), Three Arrows Capital (3AC), and other firms going bankrupt as a result of a domino effect. Billions lost. Dumpster fire doesn’t describe it.
Risks
Oh, hell ya, there are risks. Do you know who doesn’t like stablecoins very much? Central banks. Regulators. Politicians. Entities like the U.S. Treasury and the U.S. Federal Reserve prefer to have a monopoly on the money printing machine going brrrrrrr – stablecoins can be issued with little to no oversight and make money printing go brrrrrr without a bunch of boring meetings and scheduled pressers.
Additionally, doing your due diligence is difficult because not all stablecoins are transparent about what is backing their stablecoin. For example, Tether used to say for every USDT out in the market; there was $1 USD in reserve. That’s no longer the case; instead, it is considered asset-backed. As of September 30, 2022, 58.1% of Tether is backed by U.S. T-bills.
And with central banks around the globe considering or already creating their own Central Bank Digital Currencies (CBDCs), the current stablecoins may become moot, regulated out of existence, or made illegal in some jurisdictions.