Are Stablecoins Really Secure?

Cryptocurrencies are very risky investments because their prices change a lot compared to regular money. But the price of some coins is meant to stay the same. “Stablecoins” are cryptocurrencies that are made to be linked to another cryptocurrency, fiat cash, or exchange-traded commodities.

How do Stable Coins Work?

For other asset-backed stablecoins, the process is the same: the company behind the currency must show that it has enough of the dangerous asset to cover the number of coins that will be released. When people buy coins, they have to make more of them and buy more of the stock. If they sell the coins, they have to burn them and pay the buyer back.

When people use stablecoins, they have to trust a third party, which isn’t always what they want. Bitcoin is used to back up some stablecoins. There is no need to trust a third party because everything is done on the blockchain and carried out by smart contracts. The problem with crypto-backed stablecoins is that you have to put up a lot more collateral than the coin is worth to make up for the instability of cryptocurrencies.

Stablecoins that are not backed by assets are much more difficult. These coins are used to keep track of the price of a certain thing, but having the coins does not give you the item. Algorithms keep track of how many coins there are and how much money is in circulation. This keeps the price fixed. To keep the price steady, a seigniorage shares plan could be used. When the price goes up, the system makes more items available, and when the price goes down, the number of items available goes down. Let’s look at this method in more depth.

A smart contract is in charge of the seigniorage shares method. Let’s say this money is trying to keep its price at USD1. If the price is more than $1, the smart contract will increase the supply, sell more tokens, and make money. The money made is called seigniorage. If the price goes below $1, the smart contract will do the opposite. The earnings from seigniorage are used to buy back some of the stock, which drives up the price.

The problem comes when the smart contract’s seigniorage gains run out but the price stays below USD1. In this case, seigniorage shares must be made available to buyers with the promise of seigniorage payments in the future. After selling the seigniorage shares, the smart contract will have enough money to raise its set price to USD1. Problems happen when no one wants to buy the seigniorage shares. If this happens, the project will fail because the price can’t be kept up, and public opinion will drop by a lot. So, this plan depends on the community continuing to grow and on the desire for the currency going up.

How Soes a Stablecoin Stay Stable?

Most stable coins are backed by some kind of collateral object. You can trust that the stablecoin is worth what it should be because it can be traded for good security. The same market forces that are always pushing and pulling on the value of a stablecoin can also be used to keep stablecoin fixed. If a stablecoin starts to fall below its peak because the market has been oversold, buyers (or bots) can buy the stablecoin on the market and exchange it for the backing collateral. When you buy the market’s stablecoin, you make it less available and raise its value.

But not all stablecoins are the same, and the way they are linked to collateral might change based on how the peg is kept.

What the government does

Since there aren’t any laws about stablecoins, it’s easier for their issuers to make false claims about their support, which makes some of them possibly dangerous. This could change soon, and if it does, new rules could change how safe and valuable some stablecoins are.

Governments could make stablecoin issuers follow the same rules as banks, especially when they make claims about reserve assets. Stablecoins could go down if issuers refuse or can’t meet any new legal requirements. On the other hand, stablecoins that can meet legal requirements are likely to get safer, more widely accepted, and better at what they do.

What Kinds of Stablecoins Exist?

Stablecoins fall into one of three groups because they are backed by different assets: You can learn a lot about stablecoins by doing a lot of research on the topic. There are many different kinds of stablecoins, but they all start with the same four basic collateral designs.

Stablecoins fall into one of four groups based on how their security is set up:

Stablecoins backed by Fiat

Stablecoins can be made that are backed by cash or money equivalents. Banks all over the world print paper currencies, such as the US dollar, the British pound, and the euro. As of May 2022, the three most popular stablecoins backed by real money in terms of market capitalization were Tether, Binance USD Coin (BUSD), and USD Coin. (USDC).

The stablecoin was mostly backed by US money and government debt as of March 31, 2022, according to Binance, which was in charge of it and Paxos, which issued it. Circle and Coinbase have joined forces to make USDC, which is backed by similar assets and released by Circle. This partnership is called Center.

There is no one way to keep track of details about different currencies. How these stocks are accounted for is also not clear and changes from time to time. This problem has been plaguing Tether, which is the biggest US dollar stablecoin, because it is not clear what the currency is based on. Several organizations gave Tether a fine for illegally sharing reserve information.

Stablecoins backed by goods

Stablecoins that are backed by gold, oil, or real estate are called “commodity-backed.” Tether Gold (XAUT) and Paxos Gold are two of the gold-backed stablecoins that trade the most often. (PAXG). But remember that the value of some things can and will change, so you should be careful if you want to invest in them.

Stablecoins are a type of security that is backed by a commodity. This gives buyers access to investments that they might not be able to get otherwise. In many countries, it is hard and expensive to get a gold bar and store it somewhere safe. Because of this, actual goods like gold and silver are not always a good choice. People can use commodity-backed stablecoins if they want to trade tokens for cash or become the owner of the underlying product.

Paxos Gold (PAXG) stablecoin users can either sell their tokens for cash or buy the gold that backs them. A pound of Good Delivery gold bars in London can cost anywhere from $370 to $430 per ounce, but customers need at least 430 PAXG to receive tokens. After token users store gold, it can be taken out of vaults all over the United Kingdom.

Stablecoins backed by crypto

When you think about stablecoins backed by cryptocurrencies, this may seem out of place. You ask, “What about how volatile the bitcoin market is?” Is it possible to use cryptocurrencies to help stablecoins? Stablecoins backed by crypto are less controlled than stablecoins backed by fiat money. Stablecoins are often overcollateralized with too much collateral so that they can handle market instability. Let’s look at an example to learn more about how a stablecoin can be backed by crypto.

To get $500 worth of stablecoins, you’ll need to put $1,000 worth of Ether into your account. So, you can see that stablecoins are backed up to 200%, which means that their price could drop by 25%. After the price drop, you would still have $750 worth of Ether and $500 worth of stablecoins. Stablecoins will be sold quickly if the value of the cryptocurrency they are based on drops enough.

Stablecoins without backing

The fourth type of stablecoin would be ones that are not backed by anything or are based on algorithms. “Non-collateralized” refers to stablecoins that are not backed by assets or collateral. So, how can stablecoins that don’t have any security be called stablecoins?

In non-collateralized stablecoins or algorithmic stablecoins, the amount of stablecoins is controlled by a program. This method is also called “seigniorage shares.” By making more stablecoins, prices for the money will become more stable again. When coin trade is slow, it is normal for people to buy coins from the market to limit the number of coins in circulation.

Theoretically, stablecoins based on algorithms for supply and demand could make the market more stable. The last thing to say is that algorithmic stablecoins are not controlled by any one person or group. On the other hand, automated blockchains need to keep growing in order to work. algorithmic stablecoins are not backed by any real assets. In a financial collapse, this means that everyone could lose money.

Which Stablecoin is The Safest?

USDC is often seen as the most stable currency that is also the best. Second, when it comes to market value, Tether is second only to Bitcoin. However, many crypto fans have lost faith in Tether because of its lack of openness and history of lawsuits. A third-party audit of the USDC’s asset reserves shows that it was given by members of Coinbase, a reputable organization.

Some cryptocurrency buyers who like the idea of decentralization think that Dai is safer than USDC in case of an attack or collapse because it doesn’t have a central issuer. Dai is the most popular decentralized stablecoin, and its market value is the fourth largest.

Lastly, the best stablecoin relies on how you think about safety and what you want from a stablecoin.