Exploring Stablecoin Alternatives: Beyond USDT

Bitcoin is a type of cryptoasset, but it is not classified as a stablecoin. The value of cryptoassets like Bitcoin is highly volatile, often experiencing significant fluctuations over short periods. This instability is due to their lack of backing by tangible assets, making them a riskier choice for transactions. As a result, Bitcoin and similar cryptoassets are not commonly used for everyday payments.

Another key distinction between stablecoins and cryptoassets like Bitcoin lies in their issuance. Bitcoin is created through computer code on a decentralized network that is not managed by any single entity or organization.

While many stablecoins are supported by tangible assets, some are not. Instead, these stablecoins rely on technical mechanisms, like reducing the coin supply to create scarcity, in order to maintain a fixed price. These are known as algorithmic stablecoins, and they can carry more risk compared to asset-backed stablecoins.

Why Are Stablecoins Important?

Bitcoin remains the most well-known cryptocurrency, but its price is highly volatile. For example, its value surged from under $5,000 in March 2020 to over $63,000 in April 2021, only to drop nearly 50% within two months. Even within a single day, Bitcoin’s price can swing dramatically, often fluctuating by more than 10% in just a few hours.

While such volatility may appeal to traders, it makes everyday transactions risky for both buyers and sellers. Investors holding cryptocurrency for long-term gains may hesitate to use it for purchases, and merchants may be reluctant to accept it due to the possibility of a sudden price drop after a transaction.

For a currency to function effectively as a medium of exchange, particularly when it’s not recognized as legal tender, it needs to maintain relative stability to ensure it retains short-term purchasing power. In comparison, traditional fiat currencies rarely experience daily fluctuations greater than 1% in foreign exchange markets.

Stablecoins aim to solve this issue by providing mechanisms to keep their value consistent, ensuring stability in transactions.

Most popular stablecoins now 

Stablecoins may not generate the same excitement as other cryptocurrencies, largely because they don’t promise quick profits. However, some stablecoins rank among the most prominent cryptocurrencies by market capitalization. As of August 2024, USD Coin (USDC) stands at $35 billion, and Dai (DAI) at $5 billion. Another noteworthy contender is Binance USD (BUSD), which has maintained a steady presence with significant adoption in trading and payments.

Despite their popularity, the market caps of these stablecoins are small compared to major cryptocurrencies like Bitcoin, valued at nearly $1.2 trillion, and Ethereum, with a market cap exceeding $320 billion.

Algorithmic stablecoins have also been part of the landscape, though they come with their own challenges. TerraUSD, for instance, lost its dollar peg in May 2022. It relied on other cryptocurrencies and a complex arbitrage system to stabilize its value at a 1:1 ratio. However, the broader crypto market downturn and a collapse in confidence caused its value to plummet, demonstrating the risks associated with algorithmic stablecoins.

Hidden Risks of Stablecoins

At first glance, stablecoins may seem like a safer alternative to traditional cryptocurrencies, particularly because they are often backed by tangible assets. While they are less volatile than unbacked cryptocurrencies, stablecoins come with their own set of risks, including some unique challenges:

• Security Risks: Like other cryptocurrencies, stablecoins must be stored, whether in a personal digital wallet or on a trading platform. These platforms can be vulnerable to hacking or other security breaches, posing risks to users.
• Counterparty Risk: While crypto often gives the impression of decentralization, stablecoin transactions involve multiple parties, such as the entity issuing the stablecoin and the bank holding its reserves. The stability of the coin depends on these parties managing reserves and security properly.
• Reserve Risk: The reserves backing stablecoins are critical to their stability. These reserves act as the final guarantee of the stablecoin’s value. If they are mismanaged or insufficient, the issuer cannot confidently maintain the coin’s value.
• Loss of Confidence: Stablecoins not adequately backed by liquid assets like cash may lose their peg to the currency they are tied to. This happened to TerraUSD in May 2022, when it relied on other cryptocurrencies instead of hard assets for backing. As confidence in its stability collapsed, the coin’s price plummeted.

As Citrano notes, “The primary risk of stablecoins is that they aren’t fully backed by the reserve currencies they claim to be.” Ideally, issuers maintain 100% reserves in cash or highly liquid, secure investments to support the stablecoin. Anything less introduces risk into the system. Stablecoins provide a valuable solution for minimizing volatility, but understanding their risks is crucial for anyone looking to use or invest in them. 

Stablecoins offer a level of stability that is often missing in most cryptocurrencies. Users should be aware of the risks associated with holding them. While stablecoins might appear to carry minimal risk under normal circumstances, they can become significantly more vulnerable during a crisis—precisely when they are expected to provide the most security.