Why there’s so much excitement around a crypto called stablecoin

Why the Buzz About Stablecoins? Here's What You Need to Know

If you haven't heard of stablecoins yet, chances are you will soon. This segment of the cryptocurrency world is currently experiencing significant excitement, with major companies and even large banks exploring their adoption or launching their own versions. Congress is also on the cusp of adopting legislation to establish a formal framework for them, effectively integrating stablecoins into the U.S. regulatory landscape.

The reason for this buzz lies in the core concept of stablecoins, which many see as groundbreaking in the world of money. At its heart, the vision is simple: enable people and companies to transfer money digitally anywhere in the world instantaneously, free from the delays and fees associated with traditional banking and money transfer services.

However, stablecoins are not without their detractors. Being relatively new, with evolving regulations, they face scrutiny regarding their safety and have attracted illicit actors.

What Exactly Are Stablecoins? The Appeal Explained

Unlike volatile cryptocurrencies such as Bitcoin or Ethereum, stablecoins are designed to maintain a stable value. This is their key differentiator and 'secret weapon' aimed at making them far safer for everyday transactions.

The mechanism is straightforward: if you purchase a stablecoin intended to be worth $1, the issuer of that stablecoin is meant to hold $1 in reserve. These reserves can be in dollars, euros, or other valuable assets like gold. This backing is intended to ensure that when you want to cash out your stablecoin, you can do so promptly, receiving the corresponding amount of traditional currency.

A neat analogy for stablecoins is the chips you receive at a casino. You exchange traditional money for chips (the stablecoin), gamble or use them, and then exchange the chips you have left back for money. The trust in this system rests on the assumption that the casino (or stablecoin issuer) holds sufficient reserves to pay you back when you cash in your chips.

Currently, stablecoins are primarily used within the crypto world itself, often facilitating the buying and trading of other cryptocurrencies due to their ease of conversion to cash. Major players include Circle (issuing USDC) and Tether (issuing USDT).

The stablecoin market is substantial, valued at over $250 billion and projected for significant future growth, potentially reaching trillions by 2030. This growth trajectory is partly fueled by increasing interest and regulatory attention.

Legislation like the proposed GENIUS Act aims to formalize the sector, mandating that issuers hold proper one-to-one reserves and comply with anti-money laundering rules. While seen as a step towards legitimacy, some critics argue these measures may still be too weak.

The Promise of Faster, Cheaper Payments

The real-world advantage that fuels much of the excitement around stablecoins is their potential to revolutionize payments, especially in an increasingly digital and mobile world.

In some developing countries, for instance, where access to dollars can be limited, companies engaged in international trade are beginning to use stablecoins. This expedites money transfers from partners, transactions that can take days or even weeks through the traditional banking system, enabling them to settle instantaneously at a fraction of the cost.

Companies operating internationally see stablecoins as a critical 'bridge' to interact more efficiently with the global economy. Regardless of industry or size, businesses face similar hurdles with payments, particularly cross-border transactions. Stablecoins offer a potential solution to these universal payment challenges.

Beyond international business, there are potential advantages for everyday consumers and large retailers alike. Big companies could potentially benefit significantly by using stablecoins to reduce the billions of dollars they currently pay in fees for credit card transactions. While buying something online seems instantaneous, the process of settling those payments through credit card networks and banks can take days and incurs substantial costs for the merchant.

Industry experts suggest that stablecoins could dramatically speed up this settlement process, potentially leading to a 'payment revolution'.

But What About the Risks?

Despite the promising applications, a fundamental question remains: Are stablecoins truly safe?

The safety of stablecoins hinges on the trust that the issuing company is genuinely holding the equivalent reserves they claim. Issuers assert they safeguard customer money by investing in ultra-safe assets like U.S. Treasury bills. However, concerns persist.

Past investigations, such as one involving Tether and Bitfinex, have raised questions about whether proper one-to-one reserves were always maintained. While settlements have been reached, critics highlight a general lack of transparency, public audits, and external examinations for many stablecoin operations. They argue that believing issuers are holding reserves is a significant leap of faith, contrasting it with the established checks and balances present in the traditional banking and credit card systems, which offer crucial protections for consumers.

Another major concern is the potential for stablecoins to be exploited by illicit actors, such as drug dealers and scammers. The ease with which stablecoins can be transferred globally, combined with methods that can mask transaction participants, makes them attractive for money laundering and other criminal activities, complicating efforts by regulators and law enforcement.

Furthermore, some experts worry about the potential for stablecoins to pose systemic risk to the broader financial system. A primary fear is the possibility of a 'run on the bank' scenario. If a large number of stablecoin holders simultaneously tried to cash out, and an issuer lacked sufficient reserves, it could lead to a collapse akin to a bank failure.

Given that stablecoin issuers often hold reserves in traditional banks and U.S. Treasury bills, such a collapse could force them to rapidly withdraw funds from banks and sell off government debt, potentially sparking significant volatility and contagion effects across the traditional financial sector, similar to how issues in one area spread during the 2008 financial crisis.

While the severity of this potential threat is debated, the tension between the real-life potential of stablecoins and the risks inherent in this relatively new and evolving financial product remains at the heart of the discussion. Critics fear unintended consequences that may not be fully apparent yet.