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2024 Guide: Which Stablecoin is the Safest for Your Business?

8 Mins

June 28, 2024

Introduction

Digital currencies have become a promising alternative to traditional payment and settlement methods. Today, stablecoins make up around 10% of the entire cryptocurrency market by market cap. Although the 2022 cryptocurrency crash caused a temporary contraction in the stablecoin market, the overall market capitalization and trading volumes have nearly rebounded to their 2022 peak. In fact, 75% of digital asset owners now hold stablecoins. With governments around the world legislating for stablecoins as a regulated payment method, adoption and innovation are poised to accelerate.

Despite their growing presence, some businesses still view stablecoins as risky because they operate outside the traditional banking and finance ecosystem. To mitigate this risk, many businesses partner with fintech companies like TransFi. These partners handle the full exposure to stablecoins, collecting payments and managing conversions to fiat currency. This allows clients to benefit from stablecoin adoption without the associated risks.

In this article, we will assess the safety of stablecoins as a medium for payment and settlement, and as a store of value.

Are Stablecoins Safe? Unveiling the Safest Options for Your Business

To determine the safety of stablecoins, businesses must consider several key factors. In this article, we will explore how stablecoins compare to other cryptocurrencies like Bitcoin in terms of safety. We'll delve into the various types of stablecoins and how they mitigate risks, highlighting the ones you should keep an eye on. Additionally, we'll provide an overview of global regulations and their impact on the safety of stablecoins. Let's dive into the world of stablecoins and discover the safest options for your business!

Stablecoins vs. Cryptocurrencies: Which One Offers Greater Safety?

First, let's clarify what we mean by a stablecoin and how it differs from other cryptocurrencies.

Stablecoins are a unique type of cryptocurrency specifically designed to minimize price volatility. They achieve this stability by pegging their value to more stable assets, usually fiat currencies or hard commodities like gold. To maintain their stable prices, operators of stablecoins either hold physical reserves of the underlying asset or use sophisticated algorithms to balance supply and demand fluctuations. These operators are typically private organizations or foundations, such as Tether Limited for Tether or Centre, a consortium founded by Circle, for USD Coin.

Stablecoins offer a safer alternative to traditional cryptocurrencies by providing price stability, making them an attractive option for businesses and investors alike.

Criteria 1: Price Stability

Stablecoins address one of the most significant risks associated with cryptocurrencies: their notorious price volatility. Traditional cryptocurrencies, with their wild price swings, pose substantial risks for businesses relying on them for payments and settlements. This unpredictability complicates accurate pricing of products and services and makes it challenging to determine the best time to convert cryptocurrency into fiat currency. As a result, cash flow, profitability, and financial planning can all be adversely affected. Businesses holding cryptocurrencies as balance sheet assets also struggle with this instability.

However, the degree of price stability in a stablecoin largely depends on the mechanisms employed to maintain its peg. There are four primary strategies that stablecoins use to achieve this stability:

Fiat-Collateralized Stablecoins

Fiat-collateralized stablecoins, also known as off-chain stablecoins, are anchored by reserves of traditional fiat currencies, such as the US dollar, stored in a bank account or custody service. The supply of these stablecoins matches the fiat currency reserves held. Prominent examples include Tether (USDT) and USD Coin (USDC).

Commodity-Collateralized Stablecoins

Commodity-collateralized stablecoins are tied to reserves of physical assets like gold, silver, or other commodities. Each stablecoin in circulation is backed by a corresponding quantity of the commodity, ensuring the stablecoin’s value reflects that of the underlying asset. Examples include PAX Gold (PAXG) and Tether Gold (xAUT).

Cryptocurrency-Collateralized Stablecoins

Cryptocurrency-collateralized stablecoins, also known as on-chain stablecoins, are secured by reserves of other cryptocurrencies such as Ether (ETH) or Bitcoin (BTC). These stablecoins utilize smart contracts to lock in cryptocurrency reserves. Notable examples are Dai (DAI) and Wrapped Bitcoin (WBTC).

Algorithmic Stablecoins

Algorithmic stablecoins, also referred to as non-collateralized or seigniorage-style stablecoins, rely on algorithms and smart contracts to regulate their supply and maintain their value. When the stablecoin’s price rises above its peg, the algorithm increases supply to bring the price down, and reduces supply when the price falls below the peg. An example of this type is USDD.

Among the various stablecoin types, algorithmic stablecoins have proven to be less reliable, often suffering significant sell-offs when market confidence drops. A notable example is TerraUSD, which lost its dollar peg in May 2022, plummeting in value. Other algorithmic stablecoins like Basis Cash and Empty Set Dollar have faced similar failures.

Fiat-collateralized stablecoins also carry risks. In March 2023, USD Coin (USDC) dropped to 87 cents due to $3.3 billion in reserves held at the collapsed Silicon Valley Bank (SVB), causing a rapid redemption of over $1 billion in USDC and dramatic price slippage. Similarly, Tether (USDT) briefly lost its dollar parity twice in 2022, dipping as low as $0.9959 in May and $0.9975 a month later. These fluctuations, though small, can significantly impact businesses using stablecoins for payments or holding large volumes on their balance sheets.

Despite these incidents, stablecoins have shown resilience. In each case, the pegs were restored within a few days, demonstrating their ability to recover and maintain stability even amidst market turbulence. This resilience highlights stablecoins' potential as reliable tools for businesses, provided they manage the associated risks effectively.

Criteria 2: Counterparty Risk

The safety of a stablecoin also hinges on how it is issued, which can be centralized or decentralized.

Centralized stablecoins are controlled by a single entity or organization, which manages the reserves backing the stablecoin and oversees the issuance of new coins. This includes fiat-collateralized and collateral-collateralized stablecoins. Users must trust the issuer to manage reserves properly, similar to traditional banks. Businesses should seek stablecoin issuers that publish independent audits of their reserves, like Tether and USD Coin. However, counterparty risk remains, as seen with Tether, which holds reserves at Deltec Bank in the Bahamas, outside the protection of the Federal Reserve or deposit insurance.

Decentralized stablecoins, such as cryptocurrency-collateralized and algorithmic stablecoins, operate without a central entity. They use algorithms and smart contracts to manage supply and demand, with all transactions recorded on blockchains. While considered "trustless," they are influenced by governance models and protocols. Businesses should review the whitepapers, governance models, and security assessments of these stablecoins, such as those for Dao and Reserve Dollar (RSV).

Counterparty risk isn't exclusive to stablecoins; it applies to all cryptocurrencies, whether centralized or decentralized. Businesses should be vigilant about the ownership and operational protocols of any cryptocurrency.

Criteria 3: Regulations

The regulatory landscape for stablecoins is evolving positively. New regulations worldwide aim to protect merchants and customers. In the U.S., a draft bill proposes that the Federal Reserve approves non-bank stablecoin issuers, even those based abroad but operating on U.S. exchanges. Criteria for approval include maintaining and proving reserves, technical expertise, established governance, and initiatives for financial inclusion and innovation.

The EU's MiCA framework imposes new transparency and consumer protection obligations on stablecoins, while the UK's Financial Services and Markets Bill (FSMB) offers similar regulatory oversight.

Despite this progress, stablecoins and cryptocurrencies remain less regulated than traditional fiat currencies, posing risks if a stablecoin loses its peg or ceases operation. For instance, the algorithmic stablecoin Fei voluntarily shut down in August 2022 due to regulatory concerns. Over one-third of stablecoins have failed, underscoring the need to trust stablecoins with proven track records and strong management teams.

Stablecoins like the Gemini Dollar (GUSD), Binance USD (BUSD), and Pax Dollar (USDP) are regulated by the New York State Department of Financial Services. USD Coin (USDC) is regulated by the UK's FCA and the U.S. Financial Crimes Enforcement Network (FinCEN). This regulatory trajectory supports the legitimacy of stablecoins as a form of payment, providing businesses with greater confidence in their stability and safety.

Conclusion: What’s the Safest Stablecoin for Business Use in 2024?

The sheer size of the stablecoin market is a testament to its safety. Stablecoin trades worth billions of dollars occur daily, with settlements reaching approximately $9 trillion in 2023, surpassing volumes of major card networks like Mastercard and American Express. By the end of 2024, it's expected that on-chain stablecoin volumes will surpass Visa's, the world’s largest card network.

Major financial players developing stablecoin solutions should also boost business confidence. Visa is exploring using USD Coin and the Ethereum network for global settlements. TransFi offers merchants the ability to make payouts in USD Coin, facilitating easier international money transfers. TransFi’s own cross-border payment solution uses stablecoins to help businesses settle funds globally and seamlessly trade between currencies.

However, as we've explored, different stablecoins come with different risks. Algorithmic stablecoins have a poor track record of lasting success but offer operational transparency. Centralized stablecoins tend to be more stable and aligned with regulations, yet there have been instances of them losing their peg or facing controversies about their reserves.

To help businesses choose the most appropriate stablecoins, we recently published an in-depth look at the 11 best stablecoin picks. These stablecoins represent 98% of the market by cap. This maturity, deep liquidity, and scale make them more likely to withstand market shocks and navigate evolving regulations.

Among these 11 stablecoins, those with a fiat-collateralized mechanism (Tether, USD Coin, Binance USD, True, Pax Dollar, and Gemini Dollar) offer businesses the easiest way to bridge traditional and cryptocurrency payment and settlement systems, supporting a flexible approach to stablecoin adoption.

Businesses can mitigate many risks and uncertainties by processing payments and settlements through a third party. These third parties, often fintech companies like TransFi, take on the full exposure to stablecoins when converting between fiat currencies. Using TransFi’s platform, businesses can seamlessly incorporate stablecoins into their fiat payment and settlement flows, ensuring stability and confidence in their transactions.

TransFi Team

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