How stablecoin is different than other cryptocurrencies … and how it’s not

By Jeanne Sahadi, CNN Business

Cryptocurrencies are usually characterized by wild price swings and extreme volatility. But there is one cryptocurrency that is designed to be the exact opposite.

Stablecoins, as the name suggests, are intended to be stable in price. That is, they are supposed to hold roughly the same value from the day you buy one to the day you spend it or trade it in.

That’s because, unlike other cryptocurrencies, the price of most stablecoins are benchmarked to a fiat currency, such as the US dollar, or a commodity like gold, although many stablecoins today are pegged to the dollar.

So investors buy stablecoins not to make a profit but instead as a place to store money within the cryptocurrency infrastructure and to use when buying and selling other crypto assets. They also are used for other types of financial exchanges, such as lending and borrowing or sending payments overseas — for example, to family members — in a much faster, more seamless way than through other means.

“They’re a medium of exchange,” said Stephen McKeon, an associate professor of finance at the University of Oregon and a partner at a crypto-focused investment fund that he says now settles more than half its transactions using stablecoin.

How big is the stablecoin stash?

The amount of stablecoins available has grown quickly in the past year.

As of October 20, the combined supply of stablecoins from the ten biggest issuers was $127.8 billion, according to data from The Block, a provider of crypto research and analysis. That’s up from $21.6 billion just a year earlier.

The supply from the largest issuer, Tether, jumped from $16.3 billion to $72.6 billion in the same period, an increase of 345%.

The second biggest issuer, Circle, grew its supply even faster — from $2.8 billion to $32.4 billion, an increase of more than 1,000%.

What is the purpose of stablecoin?

The first stablecoin was created in 2014 to help facilitate transactions in the crypto system because at the time, banks were reluctant to give accounts to crypto companies, McKeon said.

Given the anonymity of crypto traders and the potential for money laundering, terrorist financing and tax evasion, banks weren’t keen on having such firms on their books.

“Bitcoin miners and bitcoin exchanges — everyone needed a way to use US dollars without having to use the banking system,” McKeon said.

While illicit activity is still a problem, the crypto market has grown too big for the banking industry and US regulators to ignore, and based on the surge in coins available, trust in stablecoins has been growing as well. So now banking giants and regulators have started to engage, and central banks are contemplating the possibility of creating their own digital currencies.

McKeon equates the transformation to the legal profession’s initial reluctance years ago to accept electronic signatures as legally binding.

Who regulates stablecoin and protects investors?

There is no legal federal framework yet for how to regulate stablecoins per se.

To date, regulators and states have done more to call out alleged violations by stablecoin providers under existing rules.

For example, the Commodity Futures Trading Commission asserted that for nearly four years Tether did not fully back its stablecoin with US dollars, meaning it did not have enough US dollars on hand to pay back every investor who potentially might cash out their Tether stablecoins.

“Tether failed to disclose that it included unsecured receivables and non-fiat assets in its reserves … [and it] falsely represented that it would undergo routine, professional audits to demonstrate that it maintained ‘100% reserves at all times’ even though Tether reserves were not audited,” the CFTC said.

A key concern about a company not holding adequate reserves to back up its stablecoins is that it could not meet demand if too many investors want to cash out.

Tether was ordered to pay more than $40 million in penalties to settle charges from the CFTC and from another case alleging misrepresentation brought by the state of New York.

Tether did not reply to a request for comment on the CFTC charges.

But in response to the New York case, which was settled in February with no admission of wrongdoing by the company, Tether said in a statement that “contrary to online speculation, after two and half years there was no finding that Tether ever issued Tether tokens without backing.”

Federal regulators are currently trying to draft new rules for stablecoin and better define what stablecoin is — and whether it should be regulated as a security, such as an exchange traded fund.

“In policy discussions, some suggest applying ETF regulatory frameworks to certain stablecoins; others argue for more disclosure of reserve asset breakdowns to expose potential deceptive activities,” the Congressional Research Service notes in a recent report.

Know the potential risks

Many potential investors are scared to put money into crypto because it’s still largely unregulated and it’s confusing, said Erika Rasure, an assistant professor of business and finance services at Maryville University in Missouri.

Relative to other cryptocurrencies, stablecoin is likely a safer bet if your goal is to get back the money you put in. “In a positive way, it’s the gateway drug into cryptocurrency,” Rasure said.

She also sees its value as a fast, low-cost means of trading crypto assets and moving funds across borders, which may be especially helpful to people who leave their home country to work elsewhere and want to send money back to their families.

Rasure also thinks that if ever stablecoin is more widely adopted as a means of exchange, it potentially may benefit consumers and retailers alike in terms of providing choice, greater efficiency and lower fees compared to today’s traditional banking and credit card systems.

That said, because there are so many different issuers of stablecoins and they each have their own policies and offer different degrees of transparency, you have to do your own research before buying from any of them.

“It’s important that [issuers] have the cash assets on hand to keep [their] promise. It’s a transparency issue,” Rasure said.

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