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The Pros and Cons of Stablecoins

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Stablecoins (or stable coins) seem to be more popular than sliced bread nowadays. I am just kidding of course, but crypto tokens that are backed, attached or tied to something that is deemed “stable” have certainly gained in popularity over the last year or so.

This call to fame is mostly a result of the price volatility and sharp decline in crypto prices that we’ve seen for most part of 2018 so far. What are the pros and cons of stablecoins?

Pros of Stablecoins

The biggest pro, advantage or benefit of stable coins is probably the protection it afford – real or perceived. It can help to minimize exposure to price instability (aka price volatility). Let me explain….

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Let’s assume, firstly, that you want to transfer a $100 via the blockchain from yourself to a friend in need on the other end of the globe, and secondly, that it is important to you that a $100 or something close to it arrive at the other end (and your friend is also bargaining on it). Now let’s consider your options and the scenarios that might play out:

  • The first option you have is to convert the $100 into Ethereum (ETH) or any other non-stable crypto token of your liking. You decided to send it in the form of ETH to your friend. So you’ve converted the USD into ETH and sent it to your friend in your AM. By the time your friend gets to it in his AM, due to different time zones, ETH has taken what can best be described as a royal dump. The ETH is now only worth $80. This sucks as you’ve told your friend that you would sent a $100 not $80. Your friend jump through the hoops at crypto exchange ABC and the ETH is now even worth less – and the crypto market has taken even a bigger dump. Both you and your friend are not entirely happy about how it turns out.
  • The second option you have is to convert the $100 into Tether (USDT). Tether is a stablecoin backed by the US Dollar (USD). It is openly traded on the crypto market and has a fluctuating price that is very close to $1 – depending on how good a job market arbitrage is doing at the specific moment in time. Let’s assume that the price of Tether is at $0.994520 (the price during the time of writing). You convert the $100 into USDT at that price and after the exchange fees and what not, you have about a 100 Tether to send to your friend. Lo and behold your friend gets tied up at work and can only get to the Tether a week or so afterwards – and the crypto market has taken a massive dump during that time. Yet, USDT has only changed slightly in price and after the exchanges fees, etc. you’re friend is making out like a bandit – as the $100 arrived at that end pretty much intact despite the shenanigans of the market.

It should be clear from the above that the second option – sending the money via Tether – was the best option. It is also more time and cost-effective to send it that way than to go through a bank.

Thus, it shouldn’t come as a surprise that many crypto day traders and other players in the crypto space make use of stablecoins such as USDT to protect their profits and/or earnings.

Cons of Stable Coins

Any discussion surrounding stablecoins would not be complete without considering the cons, disadvantages or risks attached to it. The biggest risk attached to stable coins are third party risk.

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For example, in the case of Tether (USDT), TETHER Limited – the company that guarantees the USD backing of Tether – could default. And even if the backing was still guaranteed or in place after such an event, it will most likely spook the market into dumping Tether tokens as if it is nobody’s business. This would not only expose those who hold Tether to price volatility, but could completely wipe out the worth of such holdings.

The same is of course true for other stable coins. Any such coin is only as strong as the person or entity that “guarantees” the backing. Keep in mind, regardless of what they tell you elsewhere, that a guarantee is nothing but a promise.

Furthermore, keep in mind, that although a stablecoin such as Tether can help to provide protection against price volatility in the crypto market, it will not necessarily preserve the purchasing power of your money. It should after all be no secret that the US Dollar has lost most of its purchasing power over the last 100 years or so.

In addition, if the crypto market shots up, you cannot really tap into the benefit of crypto price increases if you’re holding Tether. You can use it to help protect you against price volatility and price declines, but it will not do much for you when you get caught off-guard by a sudden jump in crypto prices.

There you have it, the pros and cons of stablecoins.

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Paschal Okafor is NaijaTechGuide Team Lead. The article The Pros and Cons of Stablecoins was written by NaijaTechGuide Team. The article was last modified: December 11th, 2018

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