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Yahoo U: What are stablecoins?

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·2 min read
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In a cryptocurrency world dominated by price swings, some risk-averse investors seek a digital asset with more stability. Enter the stablecoin, a type of token that is designed to carry a fixed value.

Stablecoins are intended to be — and largely have been — less susceptible to volatility because they are backed by another asset. The fixed value, in theory, is a ballast against dramatic day-to-day fluctuations like those seen in other cryptos like bitcoin (BTC-USD) and ethereum (ETH-USD).

The four main types of stablecoins are:

  • Fiat-backed

  • Crypto-backed

  • Commodity-backed

  • Algorithmic

The most utilized type of stablecoin is fiat-backed, such as Binance USD (BNB-USD), though other stablecoins may be pegged to other assets or use an algorithm to regulate the price.

Photo by: STRF/STAR MAX/IPx 2021 10/24/21 U.S. Securites and Exchange Commission (SEC) may be investigating Tether and Tether Operations Limited, a Freedom of Information Act (FOIA) request found.
10/24/21: U.S. Securites and Exchange Commission (SEC) may be investigating Tether and Tether Operations Limited, a Freedom of Information Act (FOIA) request found. Photo by: STRF/STAR MAX/IPx

For fiat-backed stablecoins, an entity issues an amount of coins representative of an actual amount of currency that they hold. For instance, an issuer may release 100 million coins backed by $100 million.

Investors who purchase the fiat-backed stablecoin would then be able to use their new coins to exchange with other blockchain-based assets. Conversely, those who already own cryptocurrencies could convert their holdings into stablecoins, which could then be redeemed for fiat currency.

Like some well-known cryptocurrencies like bitcoin and ethereum, stablecoins are popular among crypto investors. Currently, two of the top five cryptocurrencies are stablecoins, including the third-largest cryptocurrency, tether (USDT-USD). This illustrates the critical role that the class of tokens plays in cryptocurrency adoption and transactions.

The regulatory response

Regulators are currently debating how to regulate stablecoins within the financial system, and it’s unclear how permissive they will be in their framework.

SEC Chairman Gary Gensler believes that roughly 80% to 85% of trading and lending on crypto platforms involves stablecoins, per his remarks to the Penn Law Capital Markets Association.

In February 2022, the U.S. House Financial Services Committee held a hearing on stablecoins. Since then, members have begun discussing a bill that would set out rules for circulating stablecoins from an issuer and proportional reserve levels.

However, that framework could create a serious issue when regulating algorithmic stablecoins. If a dollar-pegged stablecoin for an issuer falls below a dollar, the issuer would rely on a second cryptocurrency to manipulate the price of their stablecoin back to a dollar. Regulators are not keen on this kind of manipulation, due to the risk of a run on crypto, as is what happened with Terra stablecoins recently.

To this point, Congress’s stance appears to be that stablecoin issuers should need to receive the same licensing and allowances that federally insured depository institutions, such as banks, must abide by.

For more information about cryptocurrency, check out:

Dogecoin, what is it? How to buy it

Ethereum: What is it and how do you invest in it?

The top 21 crypto leaders to watch in the back half of 2021