What is the point of a stablecoin?

Stablecoins are somewhere between fiat currencies and cryptocurrencies.
Stablecoins are somewhere between fiat currencies and cryptocurrencies.
Image: Reuters/Dado Ruvic
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Few assets are as volatile as cryptocurrencies. In the last year,  the price of Bitcoin nearly quintupled to a new high in April before losing half of its value and then rebounding. Almost all cryptocurrencies still fluctuate wildly, making them attractive for investors but risky assets for people who want to use them for one of their intended purposes: money to pay for goods and services.

That’s made stability a rare—and valuable—quality in the world of cryptocurrencies. A host of “stablecoins” are emerging to serve this need. These cryptocurrencies run on blockchains ostensibly tied to the value of government-backed currencies like the US dollar or precious metals such as silver or gold.

The largest stablecoins by market capitalization are tether, USD Coin, Binance USD, dai, and terraUSD, all tied to the US dollar, although dozens exist with an aggregate market capitalization of more than $100 billion.

But virtually none of these coins are regulated like fiat currencies or commodities. Without regulation and oversight, there’s not much assurance customers are buying what they’re sold. Despite becoming an important fixture in modern finance, some even dip below the value of the currency to which they are supposedly tied.

As is the case with all crypto, it’s still the Wild West.

Why would someone buy a stablecoin?

Today, stablecoins are generally used by crypto traders who want to keep their money invested on a crypto exchange and easily go in and out of different crypto investments without paying high fees to cash out, said Daniel Roberts, editor in chief of the news website Decrypt. They are also used for cash transactions between crypto businesses, and as a way to hold on to cryptocurrencies without the same risk of volatility.

But the coins carry an inherent risk. Almost all are backed by companies or other organizations that claim to have every invested dollar backed by real currency or assets with the equivalent value, yet there is no way to know for sure what the companies are actually holding.

For example, tether (USDT) is run by Tether Limited, which is controlled by the Hong Kong exchange Bitfinex, USD Coin (USDC) is run by a consortium started by the payment company Circle, and the coin Binance USD (BUSD) is controlled by the exchange Binance. No regulatory authority guarantees their holdings. Even Facebook tried to make a stablecoin called Libra, but that plan was shuttered under regulatory pressure and shifted to a new project called Diem, planned for possible future release.

The US is eying the digital dollar

Digital currencies are also attracting the attention of central banks developing their own national rivals to cryptocurrencies.

The US government is studying a possible digital currency known as a digital dollar or FedCoin. The digital dollar and other central bank digital currencies (CBDCs), exist as another version of government-issued money, in addition to paper notes and coins. Advocates say the digital dollar could speed up transactions and bring the disenfranchised into an increasingly cashless society.

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While the US Federal Reserve is still studying the issue, it faces pressure from China and other countries that have issued their own digital currencies. China’s CDBC, called the digital yuan, is currently rolling out as Xi Jinping’s government cracks down on cryptocurrency in the country. The Chinese government clarified its ban on crypto last week, specifying that it does not permit transactions of bitcoin, ether, or even the stablecoin tether.

How governments are regulating stablecoins

While crypto assets have evaded US government regulation for much of their history, those days may soon be behind us. Gary Gensler, the US Securities and Exchange Commission (SEC) chair, recently told The Washington Post that stablecoins are “acting almost like poker chips at the casino right now,” noting that stronger oversight is needed so consumers aren’t burned.

Gensler also told the US Senate last month that stablecoins might qualify as securities. Republican Senator Pat Toomey pushed back on that assertion, saying that stablecoins do not pass the Howey test, a Supreme Court standard for determining whether something is a regulated security.

The Biden administration is also working on new bank-like regulations on stablecoins, according to The Wall Street Journal, which it can either recommend to Congress or try to impose through the Financial Stability Oversight Council, a Treasury Department-led body put in place by the Dodd-Frank Act to protect against financial risks.

However, regulators are already moving into this space. On Monday (Oct. 4), Circle, a key backer of the popular stablecoin USDC, revealed it had been hit with a subpoena from the SEC’s Enforcement Division, for documents about its operations and products, but did not specify details.

Paxos, the company behind a lesser-known stablecoin called pax dollar (USDP), voluntarily submitted to regulation by the New York State Department of Financial Services, requiring it to meet specific benchmarks for “capital reserve, consumer protection, compliance, and anti-money laundering requirements,” the company says on its website. The company hopes that this regulation will merit trust from buyers.

Roberts said that regulation makes a lot of sense. “Something that’s built on top of another asset, should have to follow the same rules,” he said. “They’re basically tied to other securities or things that have to follow securities laws, so why shouldn’t stablecoins?”

The issue is building trust, says Hanna Halaburda, a professor at New York University Stern School of Business and a former senior economist at the Bank of Canada. At the moment, it’s up to members of the public to understand the rules governing stablecoins. Regulation can remove that burden by transferring this oversight to government agencies. “[Stablecoins rely] on the users inspecting their protocols themselves and deciding whether to trust,” she said. “That exposes users who do not have sufficient knowledge or information either to high risks or exclusion from the market.”

Now that stablecoins have a foothold in the crypto space, regulation seems imminent. While the exact plan is yet to be released, the US and other governments appear set on making sure stablecoins can live up to their name.