Are Stablecoins Truly Stable Or A Misconception?
Stablecoins remain a topic of interest for investors and traders in the crypto world. They currently represent around 2% of the total market capitalization of all cryptocurrencies, making them one of the top 5 cryptocurrencies in the space. The total value of stablecoins has surpassed $110 billion, compared to $28 bn at the start of 2021, reflecting the high institutional and retail demand in unstable times. In addition to being used as a payment method for transactions, stablecoins also contribute to the overall growth of the blockchain ecosystem, particularly DeFi.
While many view stablecoins as a potential solution to a huge price volatility issue related to digital assets, there are certain misconceptions surrounding them. As much as they are an improvement on tokens, stablecoins remain a highly volatile asset. There are other myths about stablecoins that lead people to have unrealistic expectations about their value. These include:
Stablecoins are Backed by Fiat Currency
The term ‘peg’ gets mentioned quite a bit when talking about stablecoins. It denotes the fixed value asset the stablecoin is paired to, which gives it stability. But if we examine the pegging mechanism in depth, we’ll see that stablecoins are not “fixed” to fiat currencies. Instead, they receive their ‘peg’ thanks to the support of a network of people who continuously adjust the price of their coins.
If we look at the group behind the popular platform PEG and PEG.USD, known as the PEG Foundation, we can see how their use of PEG Instance Managers maintains the cryptocurrency’s value. This strategy allows them to adjust the value of the stablecoin in relation to the value of the fiat currency it is pegged to.
A stablecoin such as the USD Coin or TureUSD differs from the US Dollar. In other words, it is not a currency but a derivative or asset based on the Dollar. This means that when you buy 1 USD Coin, you buy an asset allegedly worth $1.
Other stablecoins are backed by assets, such as precious metals, stocks, and real estate. For instance, the Bancor cryptocurrency supports the PEG stablecoin. But over the years, the crypto space has seen several issues stemming from where, how, and by whom the real-world assets were stored to maintain the ‘peg’.
Stablecoins are Immune to Market Instability
While nice in theory, stablecoins do not operate irrespective of market movements and contribute to market instability. Since they are listed and traded on cryptocurrency exchanges, they are susceptible to the same market dynamics and trends that affect the price of other crypto assets.
In addition, a stablecoin is also vulnerable to fiat currency market instability. For example, when the US dollar price falls, the price of TureUSD and PEG.USD will drop.
Stablecoins backed by assets like real estate will be vulnerable to the markets for their assets. For example, a real-estate stablecoin’s price will collapse if a real estate bubble bursts.
Therefore, stablecoins will not make cryptocurrencies or the cryptocurrency markets more stable. Conversely, stablecoins could make cryptocurrency less stable by exposing it to the stock and real estate markets.
Stablecoins can be used like fiat currency
Stablecoins are subject to the same limitations that affect other cryptocurrencies. They cannot be used to transact within digital or physical stores. There are no fiat apps, credit or debit cards that support them. For example, you cannot withdraw stablecoins from an ATM or a Binance account into a bank account. Cashing out any stablecoin means it needs to be sold first for fiat currency, just like any other cryptocurrency.
Despite their peg, stablecoins are not government-backed and thus cannot function as cash. There have been plans about issuing national cryptocurrencies that will be backed by a country’s fiat currency, but those are still in the early stages of discussion.
Stablecoins are safer than Cryptocurrencies
Stablecoins attempt to achieve price stability via different mechanisms such as over-collateralization, the use of an algorithm, etc. However, none of these methods are perfect, and stablecoins are just as volatile, experimental, and disruptive as other cryptocurrencies.
Because they create an illusion of safety, stablecoins can be more daunting to invest in and trade. Sudden price collapses can thus affect the portfolios of holders. Additionally, a false sense of safety and security can encourage complacency and risky behavior. These are just several ways stablecoins increase the risks in the cryptocurrency markets.
Stablecoins are a better investment than other cryptocurrencies
The crypto market, along with blockchain technology, is a nascent field. Having looked at how the market has developed over the last two years, it’s clear there’s a long way to go in standardizing and regulating stablecoins.
It is still early to make assumptions regarding how safe or stable stablecoins really are because they have been around for less than two years. And while stablecoins have the potential to enhance the efficiency of the provision of financial services, they also generate risks to financial stability if they are adopted at a significant scale. For the time being, stablecoins, like most cryptocurrencies, are purely speculative assets. Based on unproven technologies and business models, investors and traders currently derive most of their profits by riding market volatility.
Stablecoins have quickly become a significant part of the Dapp and crypto ecosystem, but great responsibility comes with great power. Their utility is beyond question and will continue to play a vital role in further driving crypto adoption. However, to truly cross the chasm, they need to start delivering on the promises for stability that they’re making.
It remains to be seen what strategies and mechanisms stablecoins will adopt to prove the concept. If they successfully achieve this, stablecoins may fill a crucial gap in today’s cryptocurrency market.
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Disclaimer: Although we reference “stablecoins,” we don’t claim that these assets will always hold their peg. We call SIKKA a stable asset, reflecting that it’s over-collateralization price stability has a few days lag time.