Since its inception, the stablecoin Tether has faced scrutiny over whether it is backed one-to-one by the US dollar. Although the team behind Tether has tried to calm the situation, the questions have never gone away, and it has now been revealed that only 74% of Tether is backed by USD. Such findings have created worries about whether Bitfinex – the exchange that works closely with Tether – has the funds needed to survive in this competitive market.
There are now numerous stablecoins on the market, but can you trust them?
The benefits of stablecoins
Cryptocurrency markets are notoriously volatile. Whilst this volatility has calmed somewhat in recent years due to increased liquidity, there are cryptocurrencies that can rise and fall dramatically.
To remove some of the risks associated with this volatility, stablecoins began to make an appearance. They aim to provide a peg to the US dollar so that one Tether, for example, will always equal $1.
This can be useful as converting any cryptocurrency to fiat can often be time consuming, especially large amounts. Through stablecoins, you can convert quickly and easily to a fiat denomination without all the hassle of having to withdraw from an exchange to the bank. This also allows you to re-enter the cryptocurrency markets quickly as well.
The risks of stablecoins
The popularity of Tether has shown there is an appetite for stablecoins. Tether is the eighth biggest cryptocurrency in circulation with a market cap of just under $3 billion.
Recent news has shown though that Tether is not 100% backed by the US dollar. Were there to be an equivalent of a bank run on Tether, could the company pay that money back to all those who request it?
The majority of stablecoins are also centralised, which undermines one of the central pillars of cryptocurrencies: decentralisation.
Another issue for stablecoins is that they are linked to fiat currencies – the same currencies that Bitcoin and other cryptocurrencies are attempting to replace. Should the current trade wars heighten, or should there be another financial crisis, there is the possibility that stablecoins will be backed by currencies that have massively depreciated in value themselves.
The exposure of exchanges to Tether also represents a risk. Tether is currently one of the most widely traded markets, and should the stablecoin collapse, the knock-on effects throughout the industry could be huge. The last time an equivalent happened was the MT Gox crisis. Should Tether collapse, the fallout will be much worse.
The rise of stablecoins
The success of Tether has led to many competitors entering the market, although they have yet to truly challenge Tether’s dominance. Many of these new stablecoins are backed by major companies in the industry and have stressed their one-to-one US dollar peg.
Gemini, the company run by the Winklevoss twins, released the Gemini Dollar and has proven its reserves through the accounting firm BPM, LLP. Gemini also states that it is fully regulated, calming any legal issues that might worry investors.
USD Coin was launched by Circle and Coinbase and again publishes its US dollar reserves each month through Grant Thornton LLP.
A third stablecoin has taken a more unique approach. The DAI stablecoin from MakerDAO has tried to solve the centralisation issue with stablecoins. Through its decentralised method, the company has built a stablecoin on top of the Ethereum blockchain that aims to be pegged to the US dollar.
Perhaps surprisingly, Tether still remains the dominant stablecoin in the market despite the controversy surrounding it. Its first-mover advantage has certainly helped in this regard, but the clarity and openness of other stablecoins will surely soon close the gap.
Can you trust stablecoins?
Now that there are a variety of different stablecoins available and many have proved that they are 100% backed by USD, there is definitely more trust in stabelcoins. The jury is still out on Tether though. It is likely that uncertainties surrounding Tether will continue on into the future as well.
Yet with coins such as the Gemini Dollar, the DAI stablecoin, and USD Coin, there are many other options you can use if you want to avoid the risks associated with Tether.
If you are fearful of the centralisation aspect of many stablecoins, then DAI offers an alternative, but that also comes with its own risks.
Conclusion
Stablecoins can serve a useful purpose of protecting your profits from the volatility of cryptocurrencies by providing an easy way to peg your holdings to the US dollar. Like anything in the cryptocurrency industry, there will always be risks attached to the use of stablecoins.
The centralised nature of stablecoins highlights this risk. If the company backing the one-to-one peg begins to struggle, then trust in the stablecoin may falter.
Until there is a collapse in a stablecoin, their popularity will remain as an alternative way to hedge your cryptocurrency holdings into a fiat form.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.