Stablecoins – How Risky the “Stable” Cryptocurrencies Really Are

Anyone who invests in cryptocurrencies can hardly avoid them: we are talking about the so-called stablecoins, which actually offer something like stability in the volatile crypto market due to their price link to a monetary currency or a precious metal. 

Five of the top 20 crypto projects are stablecoins that track the value of the dollar. Other projects that are pegged to the price of gold or the euro as a reference value have hardly been able to build up significant market capitalization.

Huge Market of Dollar Stablecoins

The total market of all stablecoins is currently worth about 155 billion dollars. More than 140 billion dollars are combined by the five largest dollar-based projects Tether (USDT), USD Coin (USDC), Binance USD (BUSD), TerraUSD (UST), and Dai (DAI). 

On many crypto exchanges, they can be used with a crypto trading bot Kraken to automatically buy a variety of other cryptocurrencies including Bitcoin. Also, those who sell crypto can normally get paid crypto dollars like Tether or USDC in return.

The advantages are obvious: one’s own capital remains in the crypto universe and can be reinvested immediately if needed or used for payments in the real world via crypto credit cards. Banks as intermediaries including waiting times and sometimes high transaction fees are eliminated. 

By linking the price to a monetary currency such as the dollar or the euro, one is also immune to fluctuations in value, unlike other crypto projects. So much for the theory.

Liquidity Difficult to Verify

Large stablecoins like Tether or USDC promise price stability by claiming to set aside real dollars for every crypto dollar created and spent. In practice, however, with Tether and other stablecoins, only a few percent are available as real U.S. dollar reserves in cash or secure bank deposits; the rest is covered by money market and securities.

How the collateral looks in detail and whether the dollar equivalence is actually guaranteed in the event of an emergency is difficult for customers to verify. Some even call this one of the biggest scams in the crypto scene. 

Other points of criticism include the mostly centralized issuance, without the companies behind it being subject to the same regulatory mechanisms as traditional banks, for example.

Bitcoin in Geopolitics

Going into further details about the main cryptocurrency, the first thing on our minds is that the exodus of Bitcoin miners from China has clear geopolitical implications. With China taking itself out of the game, the U.S. now provides more than a third of the computing power used to validate Bitcoin transactions. 

Mining activities have also grown strongly in Kazakhstan, Russia, or Canada. However, even broader diversification is certainly desirable.

Also of geopolitical significance may have been the adoption of Bitcoin by a first state. With this step, El Salvador in Central America went against the explicit recommendations of the International Monetary Fund (IMF) and the World Bank. It now remains to be seen whether other countries will follow suit in the current year.

Bitcoin for People Without a Bank

El Salvador’s move also put the spotlight on Lightning technology, which is built on the Bitcoin network and allows fast and cheap Bitcoin transactions. El Salvadorans, 70% of whom are unbanked, now have a secure and cheap way to receive foreign remittances that are vital to their survival. 

In general, the positive social contribution of Bitcoin is underestimated in the discussion about ESG impact. For countries with functioning banking systems such as Switzerland or Western Europe, this is likely to play a lesser role. But the low entry threshold to the Bitcoin system could be life-changing for the 1.7 billion unbanked people worldwide.

Bitcoin is More Environmentally Friendly than Gaming

Cryptocurrencies are highly damaging to the environment. They consider the often drawn comparisons of Bitcoin energy consumption with that of a country such as Argentina to be of little use.

However, according to estimates, Bitcoin consumes 188 TWh annually. That’s about 0.12% of global energy production – which is less than, for example, gold production (571 TWh), computer games (214 TWh), or annual Christmas lighting (201 TWh).

Criticism of Tether

Tether has repeatedly come in for explanation in the past. Investigations by the New York attorney general’s office ended in a settlement in 2019. Tether had to pay 41 million dollars because the value protection communicated to customers was not guaranteed in the form. 

Tether itself widely dismisses the accusation that it ever failed to have sufficient reserves. It also says it has never failed to pay out a customer who wanted to exchange their Tether for dollars.

Critics point out that the coverage does not come into play in normal cases because the circulating crypto dollars are usually not exchanged back into real dollars, but used to buy other cryptocurrencies. So Tether has never yet encountered the embarrassment of having to exchange huge sums of its own tokens for real dollars in one fell swoop.

A Banking Model without Government Backing

Image source

Thus, it remains questionable how robust the system is at all in the event of an emergency. If one of the large stablecoins collapses – for example, because there are not enough reserves in the background – it is feared that this could bring down the entire crypto market, at least temporarily. 

Every year, various smaller projects fail, causing investors to lose their money. However, the market capitalization of Tether is already so large that the company, which is backed by the operators of the crypto exchange Bitfinex, is considered “too big to fail”.

The fact that there is only a fractional reserve is actually the classic banking model, which per se is not necessarily more solid. The difference, however, is that the state steps in, along with various other precautions and regulations, in the event of an emergency and thus secures the deposits. 

This is not the case with stablecoins or crypto exchanges. The risk is therefore borne solely by the customer.

Why There Are Hardly any Euro Stablecoins

There are several reasons why there are far fewer euro-based stablecoins and they don’t really want to take off. Historically, but also for regulatory reasons, the crypto boom was fueled in the U.S. and Asia, where the dollar serves as the lead currency to this day. The comparatively small European market has always played a rather subordinate role.

Another, the rather mundane reason is the business model for stablecoins. Finding safe, short-term forms of investment in the euro area, such as government bonds, that don’t have a negative yield is incomparably more difficult than with the dollar in the U.S.

Economically, it is consequently far more difficult to issue a euro stablecoin and hedge liquidity, he adds. 

Digital Euro as an Alternative

While calls for a digital dollar issued by the U.S. Federal Reserve have been rather quiet so far, the European Central Bank (ECB) has launched a two-year digital euro project in the summer of 2021. 

A launch is targeted for 2023 at the earliest. However, many questions regarding technical implementation, privacy, and also actual benefits are currently still completely unresolved.

Theoretically, such digital currencies could also make stablecoins obsolete or less relevant sooner or later. For this to happen, however, the digital euro would also have to be used extensively and be able to be used in a similarly flexible manner as its crypto equivalent. 

Politically, this will be a big challenge to reach a consensus. On the other hand, cash usage is declining, and central banks need to ask themselves what will happen if they leave the field to others when it comes to new digital payment methods.

Stablecoins as a Male Domain

The stereotype that stablecoins and crypto in itself appeals more to men than women is once again cemented. Among the respondents of different studies, 93% were male and on average 39 years old. 

Six out of ten survey participants have a university degree or are still studying. It’s not quite that dramatic in reality, to be sure. However, 80% of our customers are still male.

One explanation for this could be that technology is still seen as a male domain. Dealing with cryptocurrencies and stablecoins is still very technical. The easier it becomes to invest, but also to hold and trade crypto, the more people will get on board with the topic – especially more women. 

In addition to interest in new technologies, a diversified investment portfolio and “protection against inflation” were cited as current motives for investing in the market.

Conclusion

Although the word cryptocurrency does not necessarily inspire stability, it is true that we are talking about a total market value of 155 billion dollars.

After analyzing the various issues that are making the industry talk, we have been able to discover the real risk involved in these stablecoins. 

Now, what the future holds and which way the latest trends of these stablecoins will go remains to be seen.