Cryptocurrencies are exciting, fast-moving, and often unpredictable. Tokens such as Bitcoin and Ethereum capture all the headlines for their potential to increase in value. Yet they also fluctuate wildly in price. That makes them difficult to utilize for day-to-day expenditure or as a stable store of value.
This is where stablecoins enter the picture.
Stablecoins are designed to hold steady in value. They offer the benefits of digital assets while avoiding the wild price swings that plague much of the crypto market. Whether you’re a casual investor, a business owner, or just crypto-curious, understanding stablecoins is key. If you’ve ever asked yourself which crypto to invest in, this topic is a good place to start.
What Are Stablecoins?
Stablecoins are cryptocurrencies that are built to hold a constant value, usually tied to something like the US dollar. Unlike Bitcoin, which suffers from prices that can go way up or way down in the span of a few hours, stablecoins are meant to be stable.
The most prevalent type is the fiat-backed stablecoin. For each digital coin that’s released, there’s meant to be one actual world dollar stored in reserve. This is what provides the coin with value and assurance that it can be exchanged at any moment. Some examples are Tether (USDT), USD Coin (USDC), and TrueUSD (TUSD).
There are also commodity-backed stablecoins, which are pegged against assets like gold or oil, and crypto-collateralized stablecoins, which are backed by other cryptocurrencies. One such is DAI, which is backed by Ethereum and controlled via a decentralized protocol.
A newer and more experimental type is the algorithmic stablecoin. They’re not backed by any outside asset. Instead, they use smart contracts to automatically adjust their supply based on demand, in an effort to stabilize the value. This method is risky and already has high-profile failures, like TerraUSD in 2022.
How Stablecoins Stay Stable
The way a stablecoin stays stable depends on how it’s designed.
If it is fiat-backed coins, then it is simple. The issuer holds cash or cash equivalents at a bank. So, if someone wants to redeem his stablecoin, the issuer reimburses him with fiat currency, thereby taking that coin out of circulation.
This is where users tie up much more crypto than the stablecoin equivalent they get. For example, you may require $150 worth of Ethereum to create $100 DAI. That additional cushion will keep everything stable even when the backing asset drops in value.
Algorithmic coins attempt to adjust supply and demand automatically. When the coin drops below its target price, the system lowers supply to push the price up. When the price rises above the target, it boosts supply. This method is very dependent on market confidence and is unstable during periods of stress.
Why Stablecoins Matter
Stablecoins are not just another type of cryptocurrency. They serve a useful purpose in the wider crypto economy by offering a stable, digital alternative to cash that does not need the involvement of traditional banks.
People use stablecoins for easy and inexpensive cross-border transfers, or to store value without having to convert back into fiat, or even for smart contracts and decentralized apps. Importantly, they now operate as a kind of digital “cash,” letting traders dynamically move in and out of more volatile assets, all while never having to leave their markets.
Businesses have started using stablecoins, too. Businesses pay their vendors, employees, and freelancers instantly with lower fees and no banking delays, which is a great help for places where traditional banking services are pricey and unreliable.
The Emergence of Stablecoins
Stablecoins have grown exponentially in recent times. Their combined market cap has surpassed $250 billion on a number of occasions, and they are among the most extensively used areas of the crypto space.
Tether (USDT) is still the most well-known by trading volume, though USD Coin (USDC) is widely regarded as more transparent regarding its reserves. Binance USD (BUSD) was also a major player before regulatory issues caused its gradual shutdown.
Stablecoins have become essential infrastructure in the crypto ecosystem, with daily use for trading, lending, borrowing, and transmitting money. But with that popularity has come increasing scrutiny from regulators.
How Stablecoins Are Regulated
Even stablecoin regulations continue to develop. In the United States, there is no single rulebook. Rather, various regulators assert overlapping jurisdiction depending on the stablecoin’s function.
If the stablecoin is promoted as an investment, then the Securities and Exchange Commission will probably have jurisdiction. If the token is a commodity, the Commodity Futures Trading Commission will have jurisdiction. If there are money laundering or other illicit activity concerns, the Financial Crimes Enforcement Network will be watching for risks.
In 2021, a presidential working group raised concern that stablecoins had the potential to cause financial system disruptions. Among its suggestions was the recommendation that issuers be more closely regulated like banks, subjecting them to strict requirements on reserves, audits, and consumer protections.
California’s Role in Crypto Oversight
Even though federal regulations are ambiguous, states have started establishing their own way regarding crypto regulation. One of the most prominent is California.
The Department of Financial Protection and Innovation has been actively regulating crypto companies in California. The state is seeking to ensure that stablecoin companies open up and are responsible, especially regarding the management of their reserves.
By introducing its own framework, California is searching for a middle ground. It wants to be a technology and finance innovator and, at the same time, provide security to consumers against risky or false practices.
A Glimpse of the Global Arena
Other countries have taken different approaches toward regulating stablecoins.
The European Union has approved a major legislative package called the Markets in Crypto-Assets (MiCA) regulation. Stablecoin rules, the law reads, will require full reserves, regular audits, and disclosures that are transparent. MiCA should be fully in force by 2026.
Singapore is at the forefront of the Asia region regarding the regulation of digital assets. It mandates the full reserve backing of stablecoin issuers and has stringent transparency requirements. Japan has followed this step by restricting the issuance of stablecoins to a limited number of licensed banks and trust firms.
China has taken a vastly different path. It has banned most privately issued stablecoins entirely and is developing its own central bank digital currency, the digital yuan.
Primary Concerns of the Regulators
There are several reasons regulators are showing such an interest in stablecoins.
One big issue is one of transparency: if a stablecoin touts its reserves as fully backed by US dollars, consumers want proof. Without regular audits and public disclosures, there’s always a risk that those reserves might not be as solid as claimed-a concern that’s dogged Tether for years and led to calls for stricter oversight.
Financial stability is another problem. If a widely used stablecoin goes bad or loses its peg abruptly, the effects may ripple forward to the entire crypto market and even traditional financial sectors.
Money laundering and terrorist financing are also on their minds. Because stablecoins can move quickly and anonymously, they give law enforcement headaches. That is why most regulators would prefer it if crypto platforms followed Know Your Customer (KYC) and Anti-Money Laundering (AML) rules, just like banks.
Central Bank Digital Currencies: A Government Response
Stablecoins have encouraged the central banks of many countries to opt for their own central bank-issued digital currency. Central bank-issued digital currencies are simply called CBDCs.
Studies on the concept of a digital dollar are already underway in the United States. Proponents believe that a CBDC would provide a more secure option than privately issued stablecoins. Since it would be government-backed, it would be simple to regulate, and maybe accessible to one and all.
Others contend, though, that an official digital dollar might expose users to the possible downsides of privacy compromise or excessive central control over private money management.
What the Future Holds
Naturally, stablecoins are not disappearing; rather, they will be essential components in a fully flowering digital finance ecosystem.
The Washington policymakers are enacting new legislation offering more explicit definitions and legal safeguards to stablecoin customers. The regulations could comprise a hundred percent reserve backing, issuer licensing, and compulsory audits.
In the meantime, mainstream finance is beginning to join in. JPMorgan has created a digital token known as JPM Coin to settle intraclient payments. Other payment and banking institutions are testing comparable innovations.
As this market matures, boundaries between crypto and traditional finance are starting to dissolve. The regulator would need to act quickly to provide sufficient protection to users without choking innovation.
