While the world continues to go gaga about Bitcoin, Ethereum, and other cryptocurrencies, stablecoins have become quite popular. They see increased usage, especially amid the current scenario, where the price of digital coins is fluctuating a lot. We’ve already covered stablecoins a fair bit, but it’s but natural for one to wonder can stablecoins remain stable given the market scenario. Let’s find that out in this piece today.
What are stablecoins?
Simply put, stablecoins have their value pegged to a currency. And thus, their price doesn’t fluctuate much despite the market conditions. Considering the US is the largest economy, most of the stablecoins are pegged to 1 USD. What that means is that the price of the stablecoin remains around $1.
How stablecoins work?
The easiest way for a stablecoin is to have the same reserves in its treasury as the currency that’s available in the market. But many stablecoins also have algorithmic backing by using not only USD reserves but many other collaterals too. Then some stablecoins have another digital currency that helps them maintain this peg (Dai is a popular example of the same with MKR tokens).
Do stablecoins really have the reserves?
This is an interesting aspect and something that has been in controversy for a long time. Tether, the largest stablecoin by market cap, says that it has equivalent dollars in the banks, but that isn’t the case. After being dragged into the courts multiple times, it recently revealed that just a quarter of its reserves are in cash or bank accounts, while the remaining is in commercial paper and corporate bonds.
Similarly, USD Coin, a stablecoin from Circle and Coinbase, has mentioned that its reserves are in insured US depository institutions and approved investments. Now that doesn’t give much idea as to how many reserves it actually has.
This lack of transparency is surely one reason to be afraid about the instability of stablecoins.
What else can destabilize stablecoins?
While the market conditions don’t impact stablecoins directly, they do have an indirect impact. Considering all trading is a psychological affair, what if all the users suddenly want to cash out their stablecoins for USD? It’s not unlikely if the market continues to be in the red. In such a case, the stablecoins won’t have enough reserves to be able to offer a 1:1 peg for a USD.
There’s also a scenario where instability in one stablecoin could impact others also as it’d create panic among users. Not to mention that it’d jeopardize the liquidity as well. So, can stablecoins remain stable? Yes, to some extent, but it will depend on the market conditions.