Top 6 stablecoins in the crypto market — what are they, how they work and why they have governments worried

• Stablecoins perform an important role of being an intermediary store of value.
• According to some experts, the rise of stablecoins helped make other cryptocurrencies more valuable by giving traders a ‘stable’ place to put their money amid the inherent volatility of crypto markets.
• They have become so deeply enmeshed in the system, that the government feels compelled to regulate entities issuing stablecoins.

The invention of money made it easier for farmers to trade a bushel of wheat for other necessities of life. IT made it easier to assign a value to goods, and trade without the inefficiencies of the barter system.

Now, with cryptocurrency, there’s a similar conundrum to solve. Bitcoin, for instance, was worth $30,000 in July but has more than doubled in value since. And, that’s after it already breached $65,000 in March before taking a nosedive.

Bitcoin’s volatility may be a boon for investors looking to make profits, but those caught at the wrong end of its price movement need a quick and easy exit into something more stable — enter, stablecoins.

What are stablecoins?

Stablecoins are the answer to the calls from early crypto investors looking for a crypto-equivalent to fiat currencies like the dollar or the rupee. It needed to be something that could reliably hold value over time without volatility and allow them to easily transfer that value. For instance, a solution that lets Bitcoin investors quickly convert their Bitcoin profits to a dollar-like value and then invest that elsewhere or simply withdraw that amount to your bank account. And, thus the ‘stablecoin’ was born, to address exactly these issues.

Why do crypto investors and traders use stablecoins?

The emergence of stablecoins was great for trade, especially since crypto trades around the clock — 24 hours a day, seven days a week — unlike stock markets. Suddenly, investors could instantly ‘cash out’ and sleep peacefully, without worrying how their crypto portfolios moved overnight. It became easier to move money in, out and between crypto exchanges with stablecoins, without waiting for tedious banking procedures. Stablecoins also made it easy for investors to hold a part of their crypto portfolio like cash – in such a way that they could readily purchase any coin at a moment’s notice without depending on their banks’ servers, which have been known to be unavailable from time to time due to ‘maintenance’.

Some cynics have even attributed the widening of crypto trading since 2014 and rising coin values to the ease of stablecoins attracting more participation in crypto markets.

Since crypto is a free market, it encouraged the emergence of competing stablecoins that function in different ways but satisfy the same basic need – of being stable in value. That means $100 in that cryptocurrency will still be worth the same amount later in the day, next day, or next month. In fact, a stablecoin that shoots or drops in value would be counted as a failure in terms of its stated objectives.

Because of the current financial system, the most used stablecoins are those that ‘peg’ their value to the US dollar. However, there are many stablecoins that are pegged to other fiat currencies, such as the Euro, the GBP, IMF’s SDR, commodities like gold, or oddly, even to other cryptocurrencies — a known example being Wrapped Bitcoin.

The top six stablecoins in the crypto market:

Source: CoinMarketCap, values as of November 9
Note: All six are pegged at 1:1 to the US Dollar, and reside as tokens on blockchains that support smart contracts, such as Ethereum, Binance Smart Chain etc.

Tether (USDT)

Tether initially launched in 2014 as RealCoin. With one Tether said to always be worth one US Dollar, its supply is only limited by claimed dollar reserves.

Being the largest stablecoin, Tether has felt pressure to compile regular reports about its reserves, to prove that it can maintain its peg to the dollar. The most recent report shows just about ten percent is held in cash or deposit form. Almost half of Tether’s reserves consisted of ‘commercial paper’ — short term debt issued by companies to raise funds — that sounds risky, but the rating is claimed to be relatively safe and classified as a ‘cash equivalent’.

Distribution of Tether’s reserves:

Source: Tether’s report for period ending June 2021, with reported asset total of $62.77 billion

However, the basic promise that every Tether is backed by dollar reserves in some form seems to have satisfied enough people to make it indispensable for crypto trade. In fact, it is so widely used that Tether changes more hands in the course of a single day, than its entire market capitalization – marking it as a trade focused currency.

USD Coin (USDC)

USDC supply is limited by its dollar reserves, and was launched in 2018. Adding to confidence, its founding member, the Coinbase crypto exchange claims to have achieved regulatory compliance. The USD Coin is accepted by most large exchanges, besides increasing usage in decentralized finance (DeFi), DApps and gaming.

Binance USD (BUSD)

BUSD was launched in 2019, with supply limited by dollar reserves that are audited monthly. One of the largest crypto exchanges, Binance, is a founding member. That means users converting fiat/crypto to BUSD get to use exchange services at zero fees, in addition to DeFi services that can earn extra.

Dai (DAI)

The Dai token is supply limited by the collateral stored in its vaults. However, that collateral is not US dollars but other cryptocurrencies, which led to a balancing act in early 2019. It can be used to trade, but is more prevalent on DeFi protocol services.

DAI was first launched in 2017, and added financial services since then. The autonomous MakerDAO governs DAI with issuance of Dai tokens being decentralised – any user is permitted to mint DAI tokens by depositing their Ether tokens as collateral.

TerraUSD (UST)

The TerraUSD stablecoin was launched in 2020, with an interesting way to maintain its peg of one UST per dollar. Its supply will algorithmically change based on Terra’s native LUNA token’s price and supply, to cause an equilibrium that will keep its value.

While it can be used for payments and trade, it is better known for DApps with DeFi services, and the Anchor Protocol that allows for deposits to earn rewards/yields passively.

TrueUSD (TUSD)

TrueUSD had a limited launch in 2018, with claims of regular audits and being the first stablecoin fully backed by the US dollar. Their audits indicate that supply is limited by the dollars they hold. As implied in the table above though, daily churn/trade is relatively low, and TUSD allows for DeFi and staking to earn returns from holdings.

Moreover, TrueUSD is partnering with a bank for digital payments, and incubating ‘digital asset to DeFi’ projects.

Risks That Cloud Stablecoins

At a broader level, stablecoins have helped enmesh cryptocurrency into the conventional finance system. Thus cryptocurrency is not running on a parallel track anymore, making it easier for economic shocks from either side to reach the other.

Also, entities that issue stablecoins amass power similar to banks but without any licenses or audit requirements. This has led to calls for stablecoins to be regulated like banks, since their activity meshes them deeply into the financial system.

Their bank-like activities mean that mis-steps would have consequences not only for the crypto economy worth almost $3 trillion, but also affect the wider global economy through companies that hoard significant amounts of cryptocurrency. Billionaire investor Mark Cuban, and MakerDAO founder Rune Christensen have both mentioned that stablecoins may be one of the first cryptocurrencies to see formal regulations.

For a US investor, easy conversion to and from stablecoins is losing its shine – the largest stablecoin entities are required to report numbers to income tax authorities, which need to be corroborated in a person’s tax filing at the end of the year. That means paperwork and records that need to be retained, for those who earn taxable amounts of income from trading in cryptocurrency.

For governments however, stablecoins are an experiment with lots to learn. The results have encouraged interest in Central Bank Digital Currency (CBDC), with 87 countries exploring this move for the ‘future of money’. If a digitally convenient CBDC becomes available, we may well see investors drop stablecoins in favour of CBDCs instead.

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