Stablecoins are touted as fool proof, fiat backed coins, but are they as stable as you think?

Let’s get down to it and find out:

First things first: What is a Stablecoin?

A Stablecoin is a utility token built upon another coin’s blockchain.

The goal of a stablecoin is to create a crypto currency that isn’t volatile and doesn’t change price. This means that while still being able to offer the convenience, the privacy, and the security of crypto, a stablecoin will also attempt to offer the same stability and trust fiat money has.

Looking at Bitcoin, for example, it was created to be used as a store of value.

However, since it is not widely adopted and lacks regulation, its price still fluctuates a lot.

On the other hand, a stablecoin which is pegged to the US Dollar, for example, should theoretically always equal one dollar, meaning that it does not share the speculative investment nature of Bitcoin, rather it works as a mean to store money using crypto technology and avoid price volatility altogether.

How do stablecoins work?

Mainly they work in two different ways: collateralization or through algorithmic mechanisms known as smart contracts.

Fiat collateralization means that each coin is backed by something.

This system, however, is far from being risk free as embezzlement and even stealing might happen in the companies which claim to have fiat collateralization for each single stablecoin.

As for smart contracts, or algorithmically pegged stablecoins, it makes auditing a simple process as you can simply consult the smart contract code.

However, there are also some drawbacks to this system as smart contract controlled stablecoins are more volatile simply due to their nature.

This means that they must manipulate the supply of their coins to adjust the price.

To keep things in balance, there are three types of algorithms which differ in terms of manipulation (Rebase, Seigniorage Supply, and Fractionally Collateralized algorithms).

One, for example, will change the number of coins in your wallet as to keep the value the same ($1).

Another will use something similar to a money printer and a bond reward system, etc.

Issues with stablecoins

Insurance won’t come to the rescue.

It is important to know that by depositing your money into a bank, savings, or checking account, it will be insured up to a certain amount.

That means that your insured money if stolen, or lost from the bank, will be repaid to you.

If a company that is operating a stablecoin goes bankrupt, your investment will be lost and you will be left empty handed.

All of the above leads to an inevitable conclusion: Fiat collateralization is a trust exercise

Collateralization claims are hard to prove and there are rumors that companies who run them might not actually be backed by true cash.

If they aren’t really collateralized and that scares people causing a bank run, consequences can be dire, possibly even unpegging them to their $1 value.

Wrapping up

Stablecoins offer stability in the crypto universe but as far as security goes, they seem to be often reliant on their user’s trust.

As many deposit their trust in stablecoins, and with no "bank runs" on sight, stability seems assured but with the rapid growing crypto universe not many stop to question weather stablecoins can succeed or not when, in fact, it should ultimately be up to the crypto community to ensure (or pressure into having) more oversight and to keep things running smoothly as possible, stablecoins included.