Estimated reading time: 3 minutes
What are Stablecoins?
Tied to a real-world currency, Stablecoins offer an alternative to the high-risk volatility of traditional cryptocurrency, such as Bitcoin or the Ethereum blockchain. However, fluctuations around the beginning of 2022, as well as a lack of protection for investors has led to calls for more regulation around Stablecoins.
How do stablecoins work?
In the cryptocurrency world, investing in Stablecoins is the equivalent to investing in tangible assets: they are, theoretically, supposed to hold their value over time. This is because the value of stablecoins are fixed to real-world fiat currency (which fluctuate much less than crypto).
For example, the popular stablecoins, Tether (USDT) and Binance USD (BUSD) are both tied to the US dollar, with tiny market caps compared to Bitcoin. Anybody who owns USDT is able to access the real USD reserve that backs these assets, exchanging the crypto for fiat money (physical cash). This is an incredibly important aspect of why Stablecoins are so stable – since other cryptocurrencies are not backed by cash reserves.
In some cases, collateralised Stablecoins are not fixed to real-world assets but instead, their retained value is controlled algorithmically. For example, the blockchain is programmed to destroy a percentage of the algorithmic stablecoin as popularity grows. This maintains exclusivity and counteracts the idea of inflation.
Even though they seem to be associated with significantly lower risk than traditional cryptocurrency, recent events with these commodity-backed stablecoins have made it clear that they are not without hazards. Moreover, the lack of global cryptocurrency regulations is leading to some loopholes around the world.
For example, TerraUSD, which is designed to have price stability above $1 recently dropped below this threshold. It led to the associated token losing almost all of its value within one day. This left many asking for increased protections, since the fiat-collateralised stablecoin was supposed to track the value of the dollar.
One of the main problems with stablecoins is that the prudential regulation which applies to financial institutions does not cover emerging cryptocurrency. This means that while new technology is being introduced all the time, there is no obligation to act prudentially.
Moreover, the whole basis behind cryptocurrency is that it is decentralised, without the input of a central bank. But when a federal reserve is required to back the crypto asset associated with it, ‘centralised stablecoins’ undermine the whole idea.
Of course, both fiat-collateralised stablecoins and non-collateralised stablecoins are a digital asset that has to be held in a wallet once bought, which leads to questions around security and access, too.
Potential regulation changes
We know that stablecoins are popular enough to warrant their own regulations, since the reserve asset category has the ability to affect the wider financial markets. But right now, the UK’s Markets in Crypto Act (which regulates the process from crypto exchange to bitcoin wallet) doesn’t have global recognition.
At the moment, China and India are two of the only countries to fully ban crypto-mining, with no country producing specific regulation around any specific coin. News from the US indicates that they are fast producing new compliance rules, although even this is likely to take some time.
At the end of the day, there really is no telling where the cryptocurrency market regulations relating to stablecoins will end up, though our Industry Data Report, Cryptopia: Regulation and Crypto on a Cliff Edge might give you some clues. What is for sure, however, is the need to manage regulatory change for financial institutions associated with cryptocurrency.
Keep up with emerging regulatory change for cryptocurrency with CUBE.