The Safety of Storing Money in Stablecoins | UPay

If you've been following the cryptocurrency industry, you've likely heard about stablecoins—digital assets that promise the stability of traditional currencies while paving the way for the future of finance. They aim to reduce the extreme price volatility typical of cryptocurrencies, making them appealing for everyday transactions and long-term investments. But are stablecoins truly as secure as they seem?

Is it really safe to store value in stablecoins? Could they be a good fit for you or your business? Let’s dive in and explore whether stablecoins represent the next frontier in secure digital finance or if there’s more to consider before making the leap.

Key Takeaways

  • Stablecoins reduce volatility by pegging their value to assets like the US dollar, making them more stable than traditional cryptocurrencies.
  • Fiat-backed stablecoins like USDT and USDC are the most common and offer strong stability, although their reserve transparency varies.
  • Stablecoins offers cross-border transactions which are often faster and cheaper than traditional banking, which benefits global transactions and remittances.
  • DeFi integration allows stablecoin holders to earn yields through lending and staking, though this involves extra risks.

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What Are Stablecoins?

Stablecoins Image 

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Stablecoins are a cryptocurrency designed to minimize price fluctuations by pegging their value to more stable assets. These assets can be fiat currencies like the US dollar or other cryptocurrencies or even be controlled by algorithms. 

Stablecoins aim to bring much-needed stability to the crypto market, offering a reliable medium for transactions and trading without the fear of extreme price changes.

Types of Stablecoins

There are several stablecoins, each with its mechanism for maintaining stability. They are:

Fiat-Backed Stablecoins

Fiat-backed stablecoins are the most common type. They are tied to a reserve of fiat currencies, such as the US dollar. For every coin in circulation, an equivalent amount of fiat currency is held in reserve. 

Examples include USDT (Tether) and USDC (USD Coin). As of 2023, USDT remains the largest stablecoin with a market capitalization of over $82 billion, while USDC follows closely with around $26 billion. These stablecoins are popular for trading and holding value in the crypto market.

Crypto-Backed Stablecoins

Crypto-backed stablecoins are supported by other cryptocurrencies. One popular example is DAI, backed by collateralized crypto assets such as Ethereum. Even though the value of crypto-backed stablecoins is tied to volatile assets, their systems are designed to adjust the collateral and maintain stability.

Commodity-Backed Stablecoins

These stablecoins are backed by physical assets such as gold or oil. They allow users to benefit from the stability and value of commodities. Examples are Paxos Gold (PAXG), Tether Gold (XAUT)

Algorithmic Stablecoins

Algorithmic stablecoins use a more complex mechanism. Instead of reserves, algorithms control their supply to maintain a stable value. An example is TerraUSD (UST), which gained popularity before its collapse in 2022. 

UST was pegged to the US dollar through algorithms, but when it lost its peg, it caused massive losses, showing the risks of this type of stablecoin.

USD Coin (USDC) is considered one of the most transparent stablecoins, with independent audits verifying that 100% of its reserves are held in cash or U.S. Treasuries.

Safety of Storing Money in Stablecoins

Stablecoin storage image

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Stablecoins offer several benefits that make them attractive for you and your businesses. The key reasons people consider stablecoins safe are as follows:

Price Stability

The primary appeal of stablecoins is their price stability. Since stablecoins are pegged to assets like the US dollar, they maintain a relatively fixed value. For instance, USDC and USDT are consistently worth $1. 

This stability protects users from the wild price swings that other cryptocurrencies like Bitcoin experience, where prices can rise or fall by 10% or more in a single day. As of 2023, USDT alone boasts a market capitalization of over $82 billion, making it one of the most trusted stablecoins.

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Low Volatility

Unlike Ethereum or Bitcoin, stablecoins do not experience significant price fluctuations. This makes them safe for people who want to hold digital assets without worrying about losing value overnight. The fixed value is a key reason businesses use stablecoins for transactions and settlements.

Cross-border Transactions

Stablecoins simplify cross-border transactions by eliminating high bank fees and delays. Sending stablecoins between countries can be almost instantaneous and costs a fraction of traditional banking methods. 

For example, a remittance using USDT on the Tron network can cost as little as $1, compared to much higher fees charged by traditional banks or services like Western Union.

Access to DeFi

Stablecoins are essential in decentralized finance (DeFi), where they enable users to earn yields by lending, staking, or participating in liquidity pools. Platforms like Aave and Compound allow users to lend their stablecoins, earning interest based on demand. 

Liquidity

Stablecoins are highly liquid and easy to convert into other cryptocurrencies or fiat money. This flexibility is one of the key reasons they are often used as a medium for trading. 

Traders can quickly swap Bitcoin or Ethereum into USDC or USDT during volatile market periods to preserve their capital. As a result, stablecoins account for a significant portion of daily trading volume in the cryptocurrency market.

Can Stablecoins Crash?

It’s possible stablecoins can crash, though it is less common than with other cryptocurrencies. Stablecoins are meant to maintain a stable value, usually pegged to a fiat currency like the US dollar, but they are not immune to failure. 

A notable example is TerraUSD (UST), an algorithmic stablecoin that collapsed in 2022. UST was designed to maintain its $1 peg through a complex system of algorithms and reserves. However, when the system failed, it caused the stablecoin to lose its peg, leading to a crash that wiped out billions of dollars in market value.

Fiat-backed stablecoins, like USDT and USDC, are considered more stable since they are backed by real assets. But even these are vulnerable to risk if there are doubts about whether they hold enough reserves. 

Are Stablecoins Regulated?

The regulation of stablecoins is still developing and varies significantly by country. In the United States, stablecoins like USDC (issued by Circle) have made efforts to operate within a regulated framework. Circle has been transparent about its reserves, issuing monthly reports verified by third-party auditors to show that US dollars or equivalent assets fully back each USDC token. 

The U.S. Securities and Exchange Commission (SEC) and other regulatory bodies, such as the Commodities Futures Trading Commission (CFTC), have started taking a closer look at stablecoins. 

For example, The “Clarity for Payment Stablecoins Act of 2023” (H.R. 4766) proposed that stablecoin issuers should be treated similarly to banks, requiring them to hold sufficient reserves and provide regular audits.

In Europe, regulations are also tightening. The European Union recently introduced its Markets in Crypto-Assets (MiCA) regulation, which lays out specific requirements for stablecoin issuers, including the need for detailed disclosure about reserves, redemption rights, and governance. These measures aim to ensure greater transparency and consumer protection across the EU market.

In contrast, China has taken a more restrictive approach. As part of its wider enforcement of crypto activities, the country has completely banned the use of stablecoins and other cryptocurrencies. This ban came after the government issued its central bank digital currency (CBDC), the digital yuan, which it promotes as the primary digital asset for transactions.

Stablecoins accounted for over 15% of the total cryptocurrency trading volume in 2023, underscoring their role as a preferred medium of exchange in the crypto market.

Can Stablecoins Be Hacked?

 A dark person hacking stablecoins
Source: Unsplash

Stablecoins can be hacked, but it's usually not the stablecoins themselves that are targeted; rather, the platforms, smart contracts, or wallets that interact with them are at risk. Stablecoins like USDT (Tether), USDC (USD Coin), and DAI operate on blockchain networks, which are generally secure due to their decentralized nature. 

However, the infrastructure around stablecoins—such as cryptocurrency exchanges, decentralized finance (DeFi) platforms, and digital wallets—can be vulnerable to hacking and exploits.

Hacking Incidents Involving Stablecoins

One of the most significant hacks involving stablecoins occurred in 2021 when the Poly Network was attacked. In this breach, hackers exploited vulnerabilities in the network's code and stole over $600 million worth of various cryptocurrencies, including stablecoins like USDT and USDC. 

Fortunately, most of the stolen funds were returned after negotiations, but the incident highlighted the risks that even widely used platforms can face.

Another risk involves smart contracts, which are automated programs that run on blockchain platforms and often manage decentralized finance (DeFi) applications. These smart contracts can have bugs or vulnerabilities, which hackers exploit to steal funds. 

For example, in 2020, a vulnerability in a DeFi platform allowed attackers to steal $14.5 million worth of DAI. In these cases, it's not the stablecoin itself that is at fault but the smart contract that manages its use in DeFi protocols.

Exchange and Wallet Vulnerabilities

Exchanges and digital wallets, where stablecoins are stored and traded, are also frequent targets for hackers. In 2019, the Binance exchange suffered a major hack where attackers stole $40 million worth of Bitcoin, highlighting the vulnerability of centralized platforms. 

If a similar hack occurred with stablecoins, users could lose their holdings if the exchange does not have adequate insurance or security measures in place.

Comparing Stablecoins with Other Cryptocurrencies

When it comes to cryptocurrencies, stablecoins stand out for their unique features compared to traditional cryptocurrencies like Bitcoin and Ethereum. Below is a comparison of stablecoins and other major cryptocurrencies, highlighting key attributes.

FeatureStablecoins (e.g., USDC, USDT)Traditional Cryptocurrencies (e.g., Bitcoin, Ethereum)
Value StabilityPegged to stable assets (e.g., US dollar), maintaining a steady value.Highly volatile; prices can fluctuate significantly. For example, Bitcoin can swing from $30,000 to $60,000 in a matter of weeks.
Use CasePrimarily used for transactions and as a store of value in DeFi.Used for various purposes, including as a digital currency (Bitcoin) or for smart contracts (Ethereum).
VolatilityLow volatility makes them safer for everyday transactions.High volatility can lead to potential gains or losses, making them riskier for daily use.
RegulationOften subject to regulatory scrutiny to ensure transparency and backing.Less regulated, which can lead to uncertainties regarding their legality and security.
LiquidityHighly liquid, easily convertible to fiat or other cryptocurrencies.Liquidity varies; major cryptocurrencies like Bitcoin and Ethereum are highly liquid, but smaller altcoins may not be.
Transaction SpeedTypically fast and cost-effective for transactions.Speed varies by network; Bitcoin transactions can take longer and incur higher fees during peak times.
User BaseAppeals to businesses and users seeking stability and lower risk.Attracts investors and users interested in speculation and potential high returns.

Which Is the More Stable Asset to Invest In?

When considering stablecoins like Tether (USDT), USD Coin (USDC), Binance USD (BUSD), and Dai (or DAI), it's essential to understand their stability and reliability. Each stablecoin operates differently in terms of backing, transparency, and regulatory compliance, which can impact its safety as an investment.

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Tether (USDT)

Tether (USDT) is the largest and most widely used stablecoin, with a market cap exceeding $83 billion as of early 2023, according to Statista. USDT is pegged to the US dollar and is mainly backed by cash reserves, commercial paper, and other short-term assets. 

However, Tether has faced scrutiny regarding the transparency of its reserves. The New York Attorney General fined Tether in 2021, alleging that it wasn’t fully backed by fiat as it claimed, which Tether later addressed with improved reserve disclosures. 

Despite these issues, USDT remains highly liquid and accessible, making it a popular choice among traders.

USD Coin (USDC)

USD Coin (USDC) is considered one of the most transparent stablecoins. Circle publishes monthly attestations, showing that USDC is fully backed by cash and short-term government bonds, providing higher confidence in its 1:1 peg to the US dollar. 

Circle’s 2021 reports confirm that 100% of USDC’s reserves are held in “cash and U.S. Treasuries,” a claim verified by independent auditing firm Grant Thornton. USDC is also highly regulated, especially in the U.S., where Circle complies with strict financial reporting standards. 

Its transparency and regulatory compliance make it one of the most reliable stablecoins, especially for U.S.-based investors.

Binance USD (BUSD)

Binance USD (BUSD) is issued by Binance in partnership with Paxos Trust Company, a regulated financial institution in the United States. BUSD is fully backed by cash and U.S. Treasuries, with Paxos providing monthly reports to ensure full collateralization. 

According to Forbes, BUSD’s transparency and compliance with U.S. regulations have helped it become a popular stablecoin, especially among Binance users. However, in early 2023, the New York Department of Financial Services directed Paxos to halt new BUSD issuance due to regulatory concerns. 

Although this limited BUSD's growth, its existing assets remain fully backed, making it a stable choice for those who already hold it.

Dai (DAI)

This is issued by the MakerDAO protocol, is a unique stablecoin that is backed not by fiat currency but by other cryptocurrencies, such as Ethereum. DAI maintains its peg to the US dollar through a complex system of smart contracts and collateralized debt positions (CDPs). 

While DAI’s decentralized nature makes it appealing to those interested in DeFi, its reliance on volatile cryptocurrencies can sometimes cause minor fluctuations around the $1 mark. 

During periods of high market volatility, the DAI may temporarily lose its peg, as seen during the 2020 “Black Thursday” market crash when the DAI traded above $1 due to increased demand for collateral. However, MakerDAO has introduced mechanisms like stability fees to reduce such risks.

Is It Safer to Keep Money in Stablecoins or in a Bank?

Deciding whether to keep money in stablecoins or a traditional bank comes down to individual priorities around stability, accessibility, and safety. Here’s a breakdown to help evaluate both options:

Safety of Deposits

Banks offer insurance, such as the FDIC in the U.S., which guarantees up to $250,000 per account holder, so your money is protected even if the bank fails. Stablecoins do not offer this kind of insurance. 

In the event of hacking incidents on exchanges or technical failures within a stablecoin issuer’s ecosystem, funds can be at risk, as seen with Tether (USDT) and other major stablecoins during exchange security.

Returns and Interest

Many banks offer very low interest rates, especially on savings accounts, which might not even keep up with inflation. 

On the other hand, stablecoins allow for higher returns when deposited in decentralized finance (DeFi) platforms or yield-earning accounts on crypto exchanges. However, these returns come with added risk, as DeFi platforms and exchanges can be subject to market volatility and regulatory action.

Accessibility and Transaction Speed

Stablecoins allow for quick transfers across borders without traditional banking fees. Sending stablecoins internationally is often cheaper and faster than using banks, especially for those who are unbanked or live in regions with limited financial infrastructure. 

However, transaction fees can vary widely depending on the blockchain used. Traditional banks still offer stability and broader recognition, especially when dealing with fiat transactions or accessing cash directly.

Transparency and Regulation

Banks operate under strict regulations with mandated transparency and regular audits, which adds a layer of trust. Stablecoins, while increasing in transparency, especially with options like USD Coin (USDC), still face regulatory challenges. 

For example, stablecoin issuers may not always maintain a full 1:1 fiat reserve, raising concerns about liquidity and solvency during economic downturns.

Future of Stablecoins

The future of stablecoins looks promising as they continue to increase alongside the broader cryptocurrency market. Several key factors are expected to influence their trajectory, including:

Central Bank Digital Currencies (CBDCs)

CBDCs are digital currencies issued by central banks, and they could significantly impact stablecoins and financial markets. As of 2023, over 100 countries are exploring or developing CBDCs, according to the Bank for International Settlements (BIS). 

Countries like China have already launched their digital yuan, and Sweden is piloting the e-krona. The emergence of CBDCs may lead to increased competition for stablecoins, as they offer a government-backed alternative. 

For instance, a digital yuan could attract users seeking a stable and regulated digital currency, potentially impacting the adoption of stablecoins like USDT and USDC.

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Regulatory Trends

In the United States, the SEC has indicated its intention to create clearer guidelines for stablecoin issuers, which may include requirements for capital reserves and regular audits. 

In the European Union, the Markets in Crypto-Assets (MiCA) regulation aims to provide a comprehensive framework for stablecoins, promoting transparency and consumer protection. As these regulations roll out, stablecoin issuers that comply will likely gain credibility, while those that fail to adapt could face operational challenges. 

A 2023 report by the European Central Bank noted that effective regulation could enhance stability and boost public confidence in stablecoins.

Integration into Traditional Finance

The integration of stablecoins into traditional financial systems is already underway, with potential partnerships between crypto companies and established financial institutions. 

For example, Visa and Mastercard have both announced initiatives to support stablecoin transactions, allowing customers to make payments using digital currencies. In 2023, Circle partnered with Visa to facilitate payments using USDC, which illustrates how traditional finance is beginning to embrace stablecoins. 

Additionally, platforms like PayPal have started allowing users to hold and transact in stablecoins, further bridging the gap between crypto and conventional finance.

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Conclusion

Determining the safety of stablecoins as a financial option depends on individual risk tolerance and financial objectives, despite their benefits in terms of stability and flexibility in the digital currency market. 

These coins serve as useful instruments for swift transactions, steering clear of the fluctuations seen in regular cryptocurrencies, and potentially generating passive earnings via DeFi platforms. 

Nevertheless, it's important to note that they do not have the usual safeguards of bank insurance, and any future regulatory adjustments could impact them.

If you are considering whether it is safe to keep money in stablecoins, be sure to select trustworthy, open options, and stay current on cryptocurrency regulations in your nation. Stablecoins offer flexibility in finance, but it is important to carefully weigh their convenience against potential risks.

FAQs

1. Should I keep my money in stablecoins?

Keeping money in stablecoins can be a good option for stability and easy access to funds. They are less volatile than traditional cryptocurrencies and can simplify transactions. However, consider potential risks, like regulatory issues or platform security. Make sure you only invest what you can afford to lose, as stablecoins do not offer the same protections as bank deposits.

2. Can you make money holding stablecoins?

Yes, you can earn money holding stablecoins by using them in decentralized finance (DeFi) platforms or lending protocols. However, returns can vary based on market conditions and platform risks.

3. Are stablecoins a threat to banks?

Stablecoins can pose a challenge to banks by providing faster and cheaper payment options, especially for cross-border transactions. They can also reduce the need for traditional banking services.

4. How do stablecoins stay at $1?

Stablecoins maintain their value around $1 through various mechanisms, depending on their type. Fiat-backed stablecoins hold reserves of fiat currency, while crypto-backed stablecoins use collateral to support their value. Algorithmic stablecoins adjust their supply using algorithms to keep their price stable. This helps prevent significant price fluctuations.

5. What countries are using stablecoins?

Stablecoins are used globally, with notable adoption in the United States, Europe, and Asia. Countries like the United States are home to prominent stablecoins such as USDC and USDT. 

Disclaimer: This article is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence before making any trading or investment decisions.

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