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Stablecoins: what are they used for – and how stable are they?

What are stablecoins?

Stablecoins are a form of cryptocurrency. Unlike Bitcoin and other speculative coins, however, stablecoins are nominally tied to the underlying assets to limit price fluctuations. This stability has made them the preferred currency for buying other cryptocurrencies.

Stablecoins first  -peared around 2014, but their use has grown r -idly since the beginning of this year. About $ 30 billion worth of coins were in circulation in January. By October this had risen to over $ 130 billion.

There are dozens of types of coins, but a handful make up most of the total value: by October, market leader Tether was worth $ 70 billion; USD Coin, which is operated jointly by the payment service provider Circle and the cryptocurrency exchange Coinbase, accounted for another 32 billion US dollars.

How are they used?

Customers buy stablecoins from exchanges, with some of that money theoretically used to buy reserves to secure assets. Stablecoins can then be used to buy other cryptocurrencies. Compared to transferring dollars, stablecoins can process deals much faster. This makes them suitable for both the acquisition of volatile cryptocurrencies and for exiting in the event of price declines.

Stablecoins have also found use in decentralized finance, where they can be used to generate revenue for customers in a variety of ways, including lending to other users or providing liquidity for trading. In the offline world, there are also reports of stablecoins being used for cross-border transfers in places where access to dollars is restricted.

Tether had released stablecoins worth $ 70 billion by October © Bloomberg

What assets are they tied to?

The vast majority of stablecoins are pegged to fiat currencies. Tether, USD Coin, and the third largest issuer, Binance USD, all state that they are pegged to the US dollar. Others are pegged to the euro and the yen, although these are only a very small part of the category. Some stablecoins are tied to gold reserves, including offerings from Tether and Paxos, which operate Binance USD.

A smaller, but still notable, proportion of these currencies are known as algorithmic stablecoins. They are linked to other cryptocurrencies, including stablecoins in some cases. Their algorithms are designed to create and destroy coins to avoid breaking the pen. The largest of these, Dai, has about $ 6 billion worth of coins in circulation.

Coinbase is behind USD Coin together with Circle
The Coinbase logo in Times Square during the company’s  -ril IPO. Coinbase and Circle are behind USD Coin © Bloomberg

How are they supported?

While issuers may say that fiat stablecoins are pegged to dollars, their reserves can be more exotic – the result of looser regulation than the rules for commercial banks or money market funds. Without having to be clear about what assets they own, different stablecoin operators have offered different details.

In Tether’s case, roughly half of its $ 70 billion holdings are in commercial p -er, a form of short-term debt. The issuer and even the country of origin of these p -ers is unknown, although the portfolio includes at least some international p -ers. The sheer size of the company’s reported reserves has also caused a stir among regulators and others who fear it could hurt financial stability. Fitch, the rating agency, warned that a liquidation of stablecoins’ holdings of commercial p -er could lead to contagion in the credit markets.

Circle and Coinbase are committed to ensuring that USD Coin is fully covered by cash and government bonds (government bonds) by the end of September. It was fully backed by dollars until March 2020, although Coinbase continued to claim it until August this year. The certificate for September is not yet available.

What are the regulators saying?

Tether has long been the target of regulators. In February it paid $ 18.5 million for a settlement with New York Attorney General Letitia Jones, who accused the company and its sister exchange Bitfinex of covering up “massive” losses. The investigation found that at times the company had no access to bank accounts anywhere in the world, despite claims it had a dollar for every tether. None of the companies admitted wrongdoing.

There is a growing belief among regulators that risks to consumer protection, the effectiveness of monetary policy and the stability of the financial system need to contain the entire sector.

In the United States, the Treasury Department-led Working Group on Financial Markets is working on an upcoming report that includes recommendations on how to regulate stablecoins.

In the UK, the Bank of England has warned that stablecoins will have to face “tough questions”. The Financial Action Task Force noted last year that the asset stabilization mechanisms could provide opportunities for market manipulation.

A report published by the Committee on Payments and Market Infrastructures – part of the Bank for International Settlements – and the International Organization of Securities Commissions in October suggested bringing stablecoins into line with existing standards for payment systems and clearing houses.

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