What are Pegged Stablecoins?
Last Update: March 8th, 2022
Stablecoins are a type of cryptocurrency that is pegged to a fiat currency, usually the US Dollar, in an attempt to remove the inherent price volatility experienced by most cryptocurrencies. Examples of stablecoins are Tether (USDT), USD Coin (USDC), Binance USD (BUSD), Dai (DAI), TerraUSD (USDT) and TrueUSD (TUSD). All of these stablecoins are pegged to the US Dollar at 1:1. They can be used as a store of value and a bridge to facilitate trading from the real-world fiat currency to the digital world of cryptocurrency.
There are several stablecoins available in the cryptocurrency market. But essentially, stablecoins are utility tokens that are used to facilitate the easy transfer of value from one cryptocurrency to another, as in trading. The reason why there is more than one type of stablecoin for the US Dollar is because of the numerous and various blockchains that exist in the cryptocurrency space. One type of stablecoin may not be available and usable in a particular blockchain, so that there is a need to create a different stablecoin that suits that particular platform. Exchanges like Binance have created their own stablecoin, Binance USD (BUSD), for faster and easier transactions in the Binance ecosystem.
Advantages of stablecoins
They act like a cryptocurrency, without the volatility
Stablecoins have several key advantages. First, they eliminate the price volatility that is common in the cryptocurrency markets, while acting like a cryptocurrency at the same time. You can accomplish any type of transaction, without banks or regulators watching your every move. You can send and receive any amount of stablecoin from one wallet to another, without anyone asking questions. It is decentralized and anonymous, just like any other type of cryptocurrency.
Reliable Store of Value
Bitcoin has been touted as an inflation hedge and a store of value; however, due to the extreme volatility and wild price swings it has experienced, parking your hard-earned money in it, just to see it lose 30% in value in less than a month, is questionable. Bitcoin may not be as reliable a store of value as most think. Timing is still everything, and buying Bitcoin remains a speculation game.
Stablecoins, on the other hand, usually pegged 1:1 to the US Dollar, and as such, they are a reliable store of value. When the overall cryptocurrency market is bearish and falling, you can transfer your Bitcoin or Ethereum to stablecoins, in order to protect your capital from being exposed to selling pressure. Your capital therefore would not lose value if the bull market turned bearish.
Types of stablecoins
These stablecoins are backed by collateral like the US dollar or other precious metals like gold or silver. The most common fiat-collateralized stable coin is Tether (USDT). They supposedly have dollar deposits equal to USDT stablecoins existing in the market. These types of stablecoins are usually audited by a third-party auditor to check.
These stablecoins are usually backed by cryptocurrencies, like Bitcoin (BTC) or Ethereum (ETH), as collateral, instead of a fiat dollar deposit. They offset the volatility by over-collateralizing the cryptocurrency. For example, you can use your $10,000 worth of Ethereum as collateral for $5,000 worth of the stablecoin Dai (DAI). Even if Ethereum’s value drops by 40%, the $5,000 worth of DAI stablecoin is still covered by the crypto-collateral.
These stablecoins are based on smart contracts. They are deemed the riskiest of the three types because they do not use any reserve. Instead, they use an algorithm to increase or decrease the supply of tokens, similar to the way a central bank does printing.
Common Issues with Stablecoins
Due to the enormous market capitalization stablecoins have built up over the years, it has become the target of scrutiny by regulators and politicians. They have asked for more regulations and monitoring for the various stablecoins. They want more frequent audits and policies, similar to the way banks and the traditional financial markets work.
There have been questions as to whether fiat-collateralized stablecoins, such as Tether (USDT), have been truthful about their 1:1 pegging to the US Dollar. There have been rumors that they actually do not have the same amount of US Dollar deposits as the existing USDT available in the market. If this is true, this could greatly affect the value and integrity of stablecoins.
No FDIC Insurance
As stated above, stablecoins can be used as a store of value. However, unlike savings accounts in banks, they are not FDIC insured. If a bank loses your money or suddenly goes bankrupt, you can collect FDIC insurance of up to $250,000. You essentially will not lose as long as you do not go above the $250,000 insurance limit if this happens. Stablecoins, on the other hand, are not covered by this insurance. If, for some reason, USDT or BUSD were to close down, you would lose all of your money.