How to Use Stablecoins: Benefits, Risks, and Popular Options

Stablecoins have become an integral part of the cryptocurrency landscape. These digital assets are supposed to be pegged to stable reserves like the US dollar, making them less volatile compared to traditional cryptocurrencies.

But, be aware, some stablecoins are really not what they pretend to be, Tether for instance. More on this further in this article.

1 Benefits of Using Stablecoins
2 Risks Associated with Stablecoins
3 Popular Stablecoin Options
4 How to Use Stablecoins
5 Be Aware of the Risks

Benefits of Using Stablecoins

Stablecoins have rapidly gained popularity in the world of cryptocurrency, offering a unique blend of stability and flexibility. Unlike traditional cryptocurrencies, which can experience extreme volatility, stablecoins are pegged to stable assets like the US dollar, providing a consistent value. That is the theory.

This supposed stability makes them an attractive option for a variety of uses, from everyday transactions to more complex financial strategies.

Whether you’re looking to safeguard your assets from market fluctuations, facilitate seamless cross-border payments, or participate in decentralized finance (DeFi) platforms, stablecoins offer numerous advantages that cater to both beginners and experienced crypto users alike.

Just remember this:

Reduced Volatility: Unlike Bitcoin or Ethereum, stablecoins maintain a consistent value, often pegged 1:1 with a fiat currency like the USD. This stability is ideal for transactions, savings, and other financial activities without the fear of sudden price drops.
Efficient Cross-Border Payments: Stablecoins enable quick and cost-effective international transfers. Traditional cross-border transactions can be slow and expensive due to intermediary banks, but stablecoins bypass these issues, offering near-instant transfers with minimal fees.
Access to DeFi Platforms: Decentralized Finance (DeFi) platforms allow users to lend, borrow, and earn interest on their assets. Stablecoins play a crucial role in DeFi by providing a stable medium of exchange and collateral that mitigates risks associated with market fluctuations.
Easy Onboarding to Cryptocurrency: For those new to cryptocurrency, stablecoins offer an easy entry point. They allow users to explore crypto markets without the stress of managing volatile assets, providing a stable value that’s easy to understand.

Risks Associated with Stablecoins

Stablecoins are designed to maintain a stable value by being pegged to a reserve asset, usually the US dollar, at a 1:1 ratio. However, this peg is not always perfectly maintained. Various factors can cause a stablecoin to deviate from its intended value.

Technical and Regulatory Risks: Sometimes, the infrastructure supporting stablecoins can fail, leading to issues with maintaining the peg. Additionally, regulatory actions against the issuing entity or changes in regulations can impact the stablecoin’s value. If a stablecoin issuer faces legal or operational challenges, it might struggle to maintain the peg.

While stablecoins offer many advantages, they are not without risks that users must carefully consider. Despite their supposed stable value, these digital assets can be vulnerable to issues such as regulatory crackdowns, transparency concerns, and technology-related vulnerabilities. The centralization of many stablecoins, such as those managed by single entities, exposes them to risks like regulatory actions or the mismanagement of reserves, which could lead to a loss of value or access.

Market Volatility and Liquidity Issues: During periods of high market volatility, the demand for or supply of a stablecoin can suddenly change, leading to temporary deviations from its peg. For example, during the March 2023 collapse of Silicon Valley Bank, USDC briefly depegged and dropped to $0.87 before recovering.

Reserve Management Concerns: The stability of a stablecoin depends on the adequacy and transparency of its reserves. If the reserves backing a stablecoin are insufficient or not properly managed, the stablecoin might not be able to maintain its peg. This concern has been notably associated with Tether (USDT), which has faced scrutiny over the transparency and composition of its reserves.

Additionally, the very stability of a stablecoin depends on the adequacy and transparency of its reserves, and any failure in these areas could result in depegging or liquidity issues. Moreover, as digital assets, stablecoins are subject to technological risks, including hacking and smart contract failures, which could lead to significant financial losses.

In short you should be aware of this:

Centralization Concerns: Many stablecoins are managed by centralized entities, which can pose risks such as regulatory crackdowns, asset freezes, or the failure of the organization. This centralization contrasts with the decentralized ethos of cryptocurrency.
Regulatory Risks: Governments are increasingly scrutinizing stablecoins due to their potential to disrupt traditional financial systems. Regulatory actions could impact their availability, legality, or use cases, leading to potential losses for holders.
Collateralization Risk: The stability of a stablecoin depends on its reserves. If the assets backing a stablecoin are insufficient or mismanaged, the coin could lose its peg, causing its value to drop unexpectedly.
Technology and Security Risks: As with all digital assets, stablecoins are subject to cyber threats. Hacks, smart contract failures, and other technical vulnerabilities can lead to loss of funds.

Popular Stablecoin Options

Tether (USDT)

Although Tether is riddled by scandals, it does remais the most widely used stablecoin. The concerns about its reserve transparency and regulatory compliance are not just a detail. Tether has not been conducting regular audits of its reserves and lacks clarity about the types of assets backing USDT. Although Tether has made ‘efforts’ to improve transparency by releasing quarterly reserve reports, questions remain about the true extent of its reserves and its ability to maintain its peg during a crisis. Additionally, Tether’s terms of service allow it to delay or deny redemptions, which will be problematic during periods of high market stress.

USD Coin (USDC)

USD Coin is considered one of the most transparent and regulated stablecoins. Issued by Circle, USDC is fully backed by cash and short-term U.S. Treasury bonds. Circle conducts monthly audits, and these reports are publicly available, which has bolstered trust in USDC. Nevertheless USDC faced a major depegging incident in March 2023 due to the collapse of Silicon Valley Bank, where a portion of its reserves was held. The peg was however restored quickly.

Dai (DAI)

DAI is a decentralized stablecoin managed by the MakerDAO protocol and is collateralized by other cryptocurrencies rather than fiat currency. This makes DAI less susceptible to the centralization risks associated with fiat-backed stablecoins. However, DAI’s reliance on volatile crypto assets for collateral means that it could struggle to maintain its peg during extreme market downturns. Despite this, DAI has remained relatively stable and continues to be a popular option for those seeking a decentralized alternative.

Binance USD (BUSD)

BUSD is a fiat-backed stablecoin issued by Binance in partnership with Paxos. It is highly regulated, with regular audits conducted by top accounting firms, ensuring that it is fully backed by U.S. dollars. BUSD operates on multiple blockchains and while BUSD has not faced the same level of controversy as Tether, its association with Binance could attract regulatory scrutiny, especially given the increasing pressure on crypto exchanges globally.