Stable coins are another segment of the cryptocurrency industry that has seen dramatic growth in recent years. The price of these coins is pegged to another asset, such as the US dollar or the value of gold. This prevents the massive price swings that you find in other cryptocurrencies.

A challenge for cryptocurrency like Bitcoin (BTC), when used as a form of payment, is that companies want to know what their assets will be worth. Let’s say you run a business and get paid in Bitcoin but need to pay your staff and vendors in dollars. If Bitcoin suddenly loses 20% of its value, then you might have a hard time meeting your obligations.

This is where stable coins come in. They offer the benefits of cryptocurrency, such as fast, cheap, and secure transactions, but with less risk of volatility. Plus, they’re extremely liquid and easy to trade, making them an ideal base currency.

If you are thinking of buying stable coins, here are some things you should know:

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1. Stablecoins are less volatile

As the name suggests, stable coins are stable. Where the prices of other cryptocurrencies can rise or fall significantly, stablecoins will not. Unless of course something dramatic happens to the asset they are linked to.

The downside is that you can also miss out on the potential for high returns over the long term, which attracts many investors to cryptocurrency. Where Bitcoin has grown almost 5,000% over the past five years, Tether stablecoin is still worth $ 1 a coin.

2. Stablecoins can be backed by different types of collateral

Each stablecoin must be backed by some sort of collateral. Here are the main ways that can work.

  • Fiat currencies (traditional): These coins are indexed to the price of a traditional currency such as the dollar. Popular examples include Tether (USDT), Gemini Dollar (GUSD), and USD Coin (USDC).
  • Other crypto-currencies: These coins are more complicated but appeal to people who don’t want to rely on traditional currencies in any form. They use smart contracts to balance volatility. Popular examples include Dai (DAI) and Havven (HAV).
  • Merchandise : The value of these coins is indexed to the price of a commodity such as gold, oil or even real estate. Popular examples include Digix Gold (DGX) and Paxos Gold (PAXG).

3. Stablecoins are always at risk

Don’t buy stablecoins thinking that you can avoid all the risks of cryptocurrencies just because there is less volatility. For example, your wallet or exchange could still be hacked. If that happens, it would be next to impossible to get your assets back – even if they are stablecoins – unless the platform is insured.

If you keep your stablecoins in a custodial wallet on an exchange, you need to consider what will happen if that exchange fails or goes bankrupt. If it was a bank account, your money would be FDIC insured up to $ 250,000. Stablecoins don’t always have this protection.

Finally, you need to make sure that the stablecoin is sufficiently backed by collateral. If there is a run on that coin, it should be possible for everyone to cash out at the same time. Unfortunately, this may not always be the case.

4. Look for a transparent and audited stablecoin

If an issuer released $ 20 million in stablecoins, it would need $ 20 million in traditional silver to back it up. But how can you be sure he has this support? Several stablecoins, like the Gemini dollar, are regularly audited by independent accounting firms to confirm the money it keeps in reserve.

In contrast, the world’s largest stablecoin, Tether, has been criticized for not fully supporting its currency. According to an investigation by the New York Attorney General (NYAG), at one point Tether was only backed by 74% reservations. If everyone had sold their Tether, some people would have ended up with nothing.

As part of its settlement agreement with the NYAG, Tether has now released more information about its assets. But this information has not been verified by an external auditor.

5. You can earn interest

One attractive aspect of stablecoins is that you can earn much higher interest rates than you would get with a savings account. Several leading cryptocurrency exchanges pay high interest rates – sometimes 5% to 10% or more – on stable deposits.

The way the stock exchanges pay such high rates is by lending your money through Decentralized Finance (DeFi). Borrowers post collateral against the loan, which should give you some protection. But if there is a sudden economic crisis or a lot of people default, it remains to be seen whether there is enough protection in place.

Stablecoins are definitely a less risky way to get into crypto. But there are still risks. And it’s also worth looking at what governments are doing in terms of launching their own digital currencies or govcoins. These would have a significant impact on the stable coin market, especially coins that are not fully guaranteed.