What are stablecoins and how do they differ from other cryptocurrencies?

The price of bitcoin, ether and other popular cryptocurrencies have plummeted this week as investors cut their losses and seek refuge in less volatile assets. A catalyst for this week’s rout Concerns are growing about so-called stablecoins, another type of cryptocurrency that is supposed to protect buyers from the sudden swings typical of virtual money.

Read on to learn about stablecoins.

What are stablecoins?

Stablecoins are cryptos linked to a reserve asset, such as a currency (like the dollar or euro) or a commodity (like gold, oil or real estate). The backing of other assets makes the value of stablecoins less prone to roller coaster price changes, hence the name.

For example, stablecoin PAXG, or Pax Gold, is linked to gold prices, while terraUSD is linked to the US dollar. There are around 200 varieties of stablecoins around the world, according to the Blockchain Council. As of Friday, the top three stablecoins by market cap were at $78.6 billion, USD coin ($49.9 billion) and Binance USD ($17.2 billion).

As of Friday, the total market cap of stablecoins was $163 billion, according to CoinMarketCap.

What are stablecoins for?

Investors use stablecoins to protect their money from sudden price swings associated with other cryptocurrencies. In effect, stablecoins are meant to serve as the tokenized version of fiat currency or other real-world assets with a fixed value.

Decentralized financial platforms like BlockFi and Celsius use stablecoins to lend cryptocurrencies to their customers. The reason they use stablecoins is that the value of collateral or coin-backed tokens is unlikely to change dramatically between the time a customer is approved for a loan and the cryptocurrency arrives in the individual’s digital wallet.

More advanced cryptocurrency investors can use stablecoins to avoid paying transaction fees on cryptocurrency exchanges such as Binance and Coinbase, many of which do not charge fees for exchanging coins for stablecoins.

Are stablecoins really stable?

Cryptocurrency creators have marketed stablecoins as safe and predictable, but as investors discovered this month, that is not always the case.

Despite being pegged to the US dollar, for example, stablecoin terraUSD has dropped to 77 cents this week. Luna, another dollar-backed stablecoin, dropped below $1 on Wednesday night; rope fell Thursday to 95 cents.

Some investors were so outraged by the devaluation of their stablecoins that they filed a lawsuit on Thursday against Coinbase. The lawsuit centers on the stablecoin GYEN, which is pegged to the Japanese yen.

“Investors placed orders believing that the coin’s value was, as advertised, equal to the yen, but the tokens they were buying were worth up to seven times the yen,” the lawsuit states. “Just like suddenly, the value of the GYEN dropped again – dropping 80% in one day.”

Why are some stablecoins falling?

Stablecoins have fallen victim to a bigger sale of cryptocurrencies which went into high speed shortly after the Federal Reserve raised interest rates by half a percentage point. Higher interest rates, combined with rising inflation and supply chain problems, have left investors fearing that the US economy will buckle under pressure in the near future.

Due to this growing economic uncertainty, many investors have shifted their portfolios to riskier assets, including stablecoins and other cryptocurrencies. The price of most cryptocurrencies has dropped from 5% to 85% in the past week, according to data from CoinMarketCap.

What are government regulators worried about?

US lawmakers are considering ways to regulate the burgeoning cryptocurrency market, and stablecoins are at the center of these discussions.

Stablecoins, in particular, need policing because of their rapidly growing popularity and because “they are backed by assets that can lose value or become illiquid during stress”, which makes them “vulnerable to runs”, according to according to a Federal Reserve report released Monday. A “run” in the banking world is when all or most account holders withdraw their money at the same time because they think the institution won’t last much longer.


Billions erased from cryptocurrency market this week

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The Fed report also noted that the stablecoin industry is “highly concentrated with the three largest stablecoin issuers – Tether, USD Coin and Binance USD – constituting more than 80% of the total market cap.”

US Treasury Secretary Janet Yellen echoed the call for regulation of stablecoins this week, noting how quickly a price drop could affect investors.

“A stablecoin known as TerraUSD experienced a rush and declined in value,” she told a Senate banking committee on Tuesday. “I think it just illustrates that this is a fast-growing product and that there are risks to financial stability and we need an appropriate framework.”

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