Stable coins are the new units in the cryptocurrency mania. Among them are Tether, Circle, Basis, and Sagacoin. Their value is tied to the euro, the dollar and other national currencies. As a value, cryptocurrencies like Bitcoin are unattractive because they can fluctuate wildly but this is not so with the stable coins. Stable coins are stable in terms of dollars or their equivalent – they do not involve financial speculation, unlike the other cryptocurrencies.
There are three types of stable coins:
The first type is the type that claims to hold dollar deposits equal to the value of its circulation. There is also the problem of expense with this type. The platform must attract one dollar of investment capital and place it in a dollar bank account before it can issue one dollar’s worth of Tether. That means that the client has now traded a perfectly liquid dollar instead of a cryptocurrency that is awkward and questionable to use.
The second type of stable coin is collateralized where the platform holds the dollar equal to a certain amount of the value of the coins in circulation. This means that the platform will buy them and will have to use their dollar reserves to keep the price from falling. Other investors will rush to get out, however, because the stock of dollar reserves is limited. This could lead to the collapse of the peg.
The third type of stable coin is uncollateralized and has many problems. If the price begins to fall, the platform buys them back in exchange for additional bonds whose price can rise in the form of additional coins. The interest will be funded out of the income earned from future coin issuance. That growth of the platform is not guaranteed.
The price of the bonds will fall if the outcome becomes uncertain. In fact, to prevent a fall in the value of the coin, more bonds will eventually have to be issued. This will make it even more difficult to meet interest obligations. There might even be no price, however low, to attract willing buyers of additional bonds. Then again the peg will collapse.
Not everybody is familiar with pegged exchange rates and therefore not everybody is familiar with their flaws including investors.
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