If you have been involved in the cryptocurrency space then you have probably heard of stablecoins. Although they are a relatively simple concept they are important to understand. All in all, they are a key component of the cryptocurrency space.
Ultimately, they provide stability and reduce volatility while also facilitating the transfer between traditional FIAT currency such as dollars and the cryptocurrency ecosystem.
That is why in this article I will be covering what stablecoins are, as well as the pros and cons of this novel technology. So without further ado, let’s dive right in.
What are stablecoins?
Stablecoins are cryptocurrencies that are pegged to traditional currencies. For instance, the most popular stablecoin tether is backed by the US dollar.
This provides a reduction in volatility while also providing exposure to traditional currencies without leaving the crypto ecosystem.
Overall, they can be traded on both centralized and decentralized exchanges which provides unmatched convenience when trading between crypto assets. Ultimately, they do not require bank transfers.
Moreover, like other cryptocurrencies, they utilize blockchain technology. This makes them transparent meaning all transactions are completely visible on the blockchain.
They are also permissionless meaning anyone can access and use them.
Not to mention, they are decentralized. Therefore, they are secured by a vast network of participants which provides resilience as there is not a single point of failure,
Hedge against volatility – this is extremely beneficial in the cryptocurrency space which has huge price swings. As this cryptocurrency is pegged to traditional currencies they suffer little volatility. This allows users to hedge their risk.
Quick transfers – stablecoins ultimately act as a bridge for currencies to crypto. Instead of going through the arduous process of constantly depositing and withdrawing money from a bank, users can utilize stablecoins to trade between cryptocurrencies directly.
Cross-border payments – stablecoins can act as a quick solution to cross-border payments and remittances. Users can send money internationally almost instantly and for a few cents. This is a huge improvement over international transfers which take up to 5 days and have a large fee attached.
Removes intermediaries – stablecoins are not governed by an intermediary. Therefore, individuals have complete control over this asset. They can transfer it freely and interact with decentralized applications without interference. Ultimately, this makes them censorship resistant.
Transparent – as stablecoins are transferred using blockchain technology the transaction information is part of the public domain. This highlights any malicious activity and facilitates auditing.
Permissionless – anyone can access stablecoin markets. This is especially important for developing countries that are unbanked. Now they have an opportunity to interact with various financial products and services.
DeFi compatibility – as stablecoins utilize blockchain technology they can be used for decentralized finance (DeFi) applications. Users can lend, borrow and stake their stablecoins. This can provide fantastic opportunities. For instance, you can generate a generous yield on your assets.
Centralization – although the settlement of stablecoins transactions is done using decentralized technology, the underlying currency reserves are centralized.
They are often contained in a few select banks. Consequently, there are just a few points of failure. If the assets of these banks are seized then this could lead to the collapse of the stablecoin as there is no longer anything backing it.
Transparency of backed assets – as the assets backing the cryptocurrencies are not using blockchain technology they cannot be easily verified. Unless third-party audits are conducted then the information surrounding these assets remains private.
Hacks & bugs – you guessed it, Hacks. You cannot talk about stablecoins without talking about the countless number of hacks. This industry has exploded in the past few years which has attracted some unwanted attention.
From phishing attacks to discord scams, hacks are rampant. Not only that, but smart contracts can fail due to bugs in the code. That is why you must use a hardware wallet to protect against hacks.
The hardware wallet I recommend is the ledger nano X. You can check out my review by clicking here.
Regulation – as the stablecoin market continues to grow it will ultimately face more regulation from authorities. This can either hinder adoption or facilitate it. Only time will tell.
Lower returns – although there is less risk in stablecoins when compared to other cryptocurrencies. The returns are also lower. When bitcoin fluctuates 100s of percentage points a year, investors can find stablecoins underwhelming.
That being said, interest rates are higher than traditional banking.
If you want to view this article in video format then check out my video below:
As you can see, stablecoins are an extremely interesting technology with several pros and cons. On one hand, it is providing new ways of interacting with the crypto space, serving the unbanked, and providing a new solution to cross-border payments.
On the other hand, the assets behind stablecoins are centralized and often lack transparency. However, this novel technology is still in its infancy and will only improve as time goes on. I hope you found this article useful and thanks for reading.
Want to learn about how stablecoins compare to CBDCs? Click here to read my article.