Stablecoins are a type of cryptocurrency linked to an asset like the U.S. dollar that doesn’t change much in value.
While the majority of the stablecoins currently in existence use the dollar to be their benchmark asset, many of them are also tied to other fiat currencies such as the yen and euro. As a result, the price of stablecoins fluctuates very little, unlike high-profile cryptocurrencies like bitcoin and ethereum that are prone to sudden ups and downs.
The first stablecoin, created in 2014, was Tether, which many other stablecoins are modeled after. For every dollar that a user deposits, they receive one token. The tokens can be converted into the original currency at any moment at a one for one exchange rate.
As of July 28, 2021, there were about US$62 billion in Tether outstanding, or a bit more than half of the $117 billion market capitalization of all stablecoins worldwide. USD Coin is the next largest stablecoin, with a market capitalization of approximately $27 billion.
Why stablecoins are important
Originally, stablecoins were primarily used to buy other cryptocurrencies, like bitcoin, because many cryptocurrency exchanges didn’t have access to traditional banking. Because they can be used anywhere, anytime, you are more useful than currency issued by countries. Transfers of money take only seconds.
Another useful feature of stablecoins is that they can work with so-called smart contracts on blockchains, which, unlike conventional contracts, require no legal authority to be executed. The software code dictates how and when money is transferred and the terms. Stablecoins can be programmed in a way that dollars cannot.
Smart contracts have given rise to the use of stablecoins not only in seamless trading but also lending, payments, insurance, prediction markets and decentralized autonomous organizations – businesses that operate with limited human intervention.
These software-based financial services collectively are called decentralized finance or DeFi.
Proponents hold that moving money via stablecoins is faster, cheaper and easier to integrate into software compared with fiat currency.
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Others argue that the financial system is at great risk because there is no regulation. In a recent paper, economists Gary B. Gorton and Jeffery Zhang draw an analogy to the middle of the 19th century era when banks issued their own private currencies. Stablecoins could cause the same problems as in the 19th century, when people couldn’t agree about the value of private currencies.
Worried that stablecoins could pose risks to the financial system, regulators have also taken greater interest in them recently.
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