What are Stablecoins and are they Cryptocurrencies?

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Interest in cryptocurrency and stablecoins has boomed in 2021 but there’s still some confusion about the role the latter plays in the burgeoning digital token ecosphere.

Whether it’s Tether (USDT), Paxos Standard or USD Coin (USDC), to name but a few, there’s a growing list of stablecoins each which its own individual use case.

A stablecoin is a cryptocurrency that’s pegged to another asset, such as gold, a fiat currency such as the UK pound or US dollar, or another reserve asset.

This gives the token stability, hence the name, and avoids the volatility associated with other cryptocurrencies, such as Bitcoin and Ethereum.

This makes stablecoins far more suited to everyday use, such as buying goods and services, as the price remains constant, give or take minor currency fluctuations, and is designed to do so over the long term.

There are a small number of more exotic stablecoins that are pegged to other cryptocurrencies using smart contracts, or even algorithms, but these have yet to reach the mainstream.

List of the top ten stablecoins by market cap

These are the top ten stablecoins by market capitalisation at the time of writing:

  1. Tether (USDT) – Market Cap $62 billion
  2. USD Coin (USDC) – Market Cap $26 billion
  3. Binance USD (BUSD) – Market Cap $11 billion
  4. Dai (DAI) – Market Cap $5 billion
  5. TerraUSD (UST) – Market Cap $2 billion
  6. TrueUSD (TUSD) – Market Cap $1.5 billion
  7. Paxos Standard (PAX) – Market Cap $890 million
  8. HUSD (HUSD) – Market Cap $511 million
  9. Neutrino (USDN) – Market Cap $396 million
  10. Gemini Dollar (GUSD) – Market Cap $301 million

What are stablecoins backed by?

As we’ve already seen, most stablecoins gain their price stability from the real-world asset they are pegged to, such as precious and industrial metals, commodities (ie oil) and fiat currencies.

Effectively they are a digital mirror image of the underlying asset that exists on the blockchain and removes many of the barriers often associated with traditional currencies.

Being backed by a real-world asset in reserve instils user confidence and ensures the stability and liquidity of the coin.

However, not all stablecoins are created equal and there have been controversies in the market.

For example, Tether, currently the largest coin by market cap, was in theory backed one-to-one with US dollars but the developers now state that around half of the reserves are actually held in commercial paper, otherwise known as corporate debt.

But so far, they’ve failed to fully disclose the issuers of this debt, although they insist it is rated A-2 or higher, the second best rating.

This lack of transparency has raised question marks over the security of Tether and other stablecoins, although this hasn’t stopped them from continuing to grow in popularity.

What are stablecoins used for?

Stablecoins act as a ‘risk-off’ asset within the cryptosphere and have brought greater stability to the entire cryptocurrency marketplace.

They enable cryptocurrency traders to secure funds in a ‘safe haven’ at times of market volatility while staying within crypto and avoiding lengthy and costly fiat conversions and transfers.

They also help to give accurate prices to other assets within the cryptosphere, especially at times of high volatility when traders may be switching between multiple coins.

Because of the predictable price of stablecoins, people also use them to facilitate quick and cheap payments around the globe confident that the value won’t fluctuate.

Stablecoins are now the most popular method of buying crypto because of the stablecoin/crypto pairs that exist on all cryptocurrency exchanges and the inherent price transparency. This is especially useful for buying cryptos which don’t have a fiat price pair.

Are stablecoins safe?

Whatever your concerns might be about the volatility of Bitcoin and other cryptocurrencies, the underlying blockchain technology has trust baked into it.

This applies to stablecoins as well, however there are concerns about the fact that stablecoins are run by organisations which control the supply and are responsible for ensuring the appropriate financial management of the coin and its corresponding assets.

Earlier I mentioned Tether and the controversy surrounding the assets that underpin the stable coin and how the people running the coin have not been as forthcoming about the reserve assets as they could have been.

This harms confidence and creates FUD (fear, uncertainty and doubt) not just with the specific coin but across the wider crypto market.

Are stablecoins regulated?

Stablecoins tend to be associated with ‘shadow banks’ – those that operate outside the jurisdiction of regulators and as such they aren’t subject to the same rules and controls, or insurances (such as the Financial Services Compensation Scheme in the UK) that govern traditional financial institutions.

There are risks in any banking system, as demonstrated by the global financial crisis of 2008. However, these are compounded in an unregulated environment where often little transparency exists.

Like cryptocurrency and blockchain technology, stablecoins are relatively new so it remains to be seen how the market matures.

Further regulation and innovation – including Central Bank Digital Currencies (CBDCs) – are likely to change the stablecoin landscape significantly in years to come.

What are CBDCs and will the UK get one?

Cryptoassets are evolving rapidly and Central Bank Digital Currencies are one of the latest developments to potentially disrupt the market.

A CBDC can best be described as a digital version of fiat money hence why they’re sometimes referred to as digital fiat currencies. While different to stablecoins, they are certainly inspired by them.

One of the main differences between a CBDC and cryptocurrency is that they are centralised (as opposed to decentralised tokens such as Bitcoin), and issued by Governments.

They are also regulated by the country’s monetary authority, which in the UK is the Financial Conduct Authority.

Although CBDCs are technically cryptocurrencies, it is likely that they will function without the need for a blockchain or ledger technology.

In the UK, the Bank of England is consulting on the so-called ‘Britcoin’ at the time of writing. You can also read more about the BoE’s CBDC proposal here.

How do stablecoins work?

As stablecoins are pegged to an underlying asset they are designed to represent the real-world value of said asset and gain their stability from collateralisation, or the backing, from it.

In the case of fiat-backed stablecoins, a reserve fund of the specific currency is kept in a traditional bank on a one-on-one ratio. For example, $1 million cash to one million coins.

When a person buys $1 worth of stablecoin, the company behind that coin mints one new stablecoin. When the coin is sold the company destroys – or digitally ‘burns’ – a stablecoin.

When it comes to stablecoins that are backed by commodities, such as precious metals like gold, the tokens give the purchaser ownership of a quantity of the asset.

For example, each PAX Gold (PAXG) token represents one troy ounce of gold which is held in a vault at Brink’s in London, UK. Tracking information relating to the gold the token represents is available to the owner.

Are stablecoins a good investment?

Because stablecoins are backed by real-world, traditional assets they are considered to be a safe investment by many market analysts.

Their lack of volatility combined with the security of the token makes stablecoins appealing to many which in theory cements their future.

In terms of being a good investment or whether you can make money with stablecoins there are several ways this is possible:

  • Commodity-backed stablecoins may rise in value if the value of the underlying asset, such as gold or oil, increases.
  • Stablecoins can be used to earn interest – rates of 9% are possible at the time of writing.
  • You can earn money by staking your stablecoins (adding them to the network to participate in transaction validation, which is similar to crypto mining).
  • Crypto-backed stablecoins may increase in value if the pegged crypto asset rises in value over time.
  • Buying stablecoins on a platform that will then lend them out and pay you a return based on their rates.

Are stablecoins taxable?

Like all other cryptocurrencies, stablecoins are taxable in the UK and are subject to the tax laws of countries around the world.

In the UK, the main taxes you’ll need to consider are Capital Gains Tax (CGT), Income Tax and Inheritance Tax (IHT), but trying to work out your liabilities and stay on the right side of HMRC can be tough.

There are ways of reducing Capital Gains Tax and mitigating Inheritance Tax on your crypto so it’s worth considering using an accountant to help establish what you need to pay.

Are stablecoins the future of money?

At present, electronic payments offered by the traditional financial services providers all require intermediaries.

This can make payments slow and costly. Cryptocurrency changed all this by stripping out the middleman and decentralised the nature of money.

Cryptos like Bitcoin are somewhat impractical as a payment method because of the price volatility they experience, whereas stablecoins are far more suited to day-to-day use because they don’t suffer the same price fluctuations.

They are fast, easy to use across the globe and do not have be routed through various intermediaries to be spent.

They bring many benefits with them and are likely to have a long term disruptive impact on the traditional financial system.

Are Ethereum, Bitcoin, XRP or Cardano stablecoins?

This can be confusing, especially in the case of Ethereum, although the short answer is no.

While the majority of the world’s stablecoins run on the Ethereum network, Ethereum itself is not a stablecoin.

Ethereum is a blockchain use for a wide range of applications, ranging from financial services to apps and games. Ether (ETH) is the native cryptocurrency that runs on the platform.

Neither Ether, Bitcoin (BTC), Ripple (XRP) or Cardano (ADA) are stablecoins.

Stablecoin v Bitcoin

There’s still a lack of understanding about the differences between stablecoins and cryptos such as Bitcoin, although it’s actually quite simple.

Bitcoin, and many other cryptocurrencies, exist purely digitally and are not backed by any real-world asset.

Bitcoin’s value depends on several factors, such as demand and scarcity, and is often seen as a store of value, such as gold.

As we have seen earlier, Stablecoins are backed by real world assets giving them an intrinsic value aside from pure speculation of market perception.

As a result, stablecoins are seen by many as a reliable and secure asset class.

What are the ‘best’ stablecoins?

In order to choose the ‘best’ stablecoins you’ll need to do your own research.

Because they are relatively new there is little historical information available about the performance of stablecoins.

And changes in how Governments regulate cryptoassets seem to happen every week.

Stablecoins such as Tether, USD Coin and Paxos Standard are all huge in the cryptosphere and supported by a wide network of financial institutions.

But these aren’t the only top stablecoins you can invest in so it’s wise to do some reading before you take the plunge.

How to buy stablecoins

Buying stablecoins is incredibly simple, especially if you’ve bought other cryptocurrencies in the past.

All you need to do is head over to your crypto exchange (or sign up for an account if you don’t have one), deposit fiat money (or use a debit/credit) card and select the stablecoin you wish to buy.

If you already hold crypto, you’ll be able to swap it for the stablecoin of your choosing directly on the exchange you use.

As with all crypto dealings, first ensure the exchange is secure and trustworthy before parting with your money.

Related link: Top 5 exchanges to buy, trade and invest cryptocurrency

Are Stablecoins available on Coinbase, Binance and other crypto exchanges?

Yes, stablecoins are widely available on all exchanges.

They are also core currencies when it comes to earning interest on your crypto and can be bought and held on crypto savings accounts such as  BlockFi and Nexo.

Holding stablecoins is a great way of earning a passive income on your cryptocurrency without worrying about the mercurial price shifts seen by cryptos such as Bitcoin and Eth.

Related link: The top 5 crypto savings and investment accounts

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Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice.

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