The Rise Of StableCoins And Their Potential Risks

Before 2015, many cryptocurrency traders chose to trade their altcoins against Bitcoin. As a result, they were exposed to extreme volatility because both altcoins and Bitcoin had very volatile price actions.

To solve this problem, a company called Tether decided to create a stablecoin with 1-to-1 valuation to the US dollar. That stablecoin is called USDT. The idea was that every USDT on the blockchain represented 1 US dollar in the issuer’s bank account. At the time, you could deposit dollars to their bank accounts, and they would give you the equivalent amount in USDT. Vice versa. You could redeem your USDT tokens, and you would get real USD wired to your bank accounts.

This concept was warmly welcomed by most crypto traders. The traders gradually adopted USDT because they started assuming that trading altcoins or even Bitcoin against a stablecoin were a much safer option for their risk management.

Since then, the popularity of USDT has kept going higher. There are more than just one stablecoin issuer nowadays. There are USDC, TUSD, PAX, BUSD, GUSD, and DAI apart from Tether itself. The total market cap of these stablecoins is now above $10 billion, which is huge.

But here’s the important question. Is it safe to keep your capital in these stablecoins?

How People Use StableCoins

Before we can analyze the risks associated with stablecoins, we must analyze how people actually use stablecoins in the first place. As mentioned above, people started using stablecoins after they realized that stablecoin provides much better capital protection than BTC for the quote currency. For example, trading ETH/USDT provides much better risk management than ETH/BTC, as you store your funds in “USDT” instead of “BTC”.

And of course, because you use a stablecoin instead of real fiat, you can easily move the money to different crypto exchanges and wallets all over the world.

Apart from capital protection, people use stablecoins to pay remote freelancers. Many remote freelancers, especially those who work in the crypto industry, use stablecoins as a form of payment. Although this only contributes to a small portion of stablecoins usage, it is good to see wider adoption of stablecoins.

Nowadays, people also use stablecoins to put their money in DeFi protocols. With the rise of DeFi and the attractiveness of liquidity mining, the demand for stablecoins like DAI and USDC also goes up. Crypto traders put their stablecoins into lending protocols to get the DeFi tokens as reward incentives.

The Risks

Stablecoin adoption rate keeps getting better and there are far more people putting their money into stablecoin than the other way around. Everything looks good for stablecoin issuers. However, not everybody thinks it’s “safe” to put their crypto capital in stablecoins. There are actually some potential risks.

First of all, we need to understand that stablecoins are still issued by private companies. While some of them have been regulated and insured, at the end of the day, you are still at the mercy of these centralized companies when you want to redeem your stablecoin tokens. Some of the stablecoin issuers also don’t have big banks as their partners.

Sometimes their banking partners are just small banks with limited liquidity. That means that we are at an even bigger risk when there are a good number of people who request massive amounts of token redemption. It hasn’t been proven yet whether these banking partners would be able to process large withdrawals or not.

And as usual, there’s this thing called “chain reaction” in the crypto market. When there are some panics caused by stablecoin risks, it’s not hard to see that the crypto market might become unstable in this particular scenario, due to how massively popular the stablecoins are in the eyes of crypto whales.

Some people try to counter this argument by saying that a decentralized stablecoin like DAI wouldn’t have any of the mentioned risks above, because DAI doesn’t have deposit/withdrawal function with fiat currencies. DAI can keep its price stable by using algorithm and crypto collaterals to peg the price.

However, this argument is weak, because Maker (the issuer of DAI) has added USDC and TUSD as collaterals to cover the issuance and price of DAI. So, whenever we have a big problem with USDC and TUSD, they might put DAI’s valuation at risk.

Conclusion

Stablecoins are great and the use cases keep expanding. It’s not merely used for crypto trading anymore but also for DeFi lending functions as well as to pay remote freelancers. Most people are quite optimistic about the growth of stablecoin adoptions.

However, it’s also important to note that stablecoin has risks in case crypto whales choose to do some kind of “bank run” in the future. While that kind of risk looks unlikely in the middle of a bull market, it’s always wise to understand that everything has its own risks.