There are a lot of new topics to keep track of these days in the world of investing – the world is getting increasingly complex and so are investment vehicles! A client asked about one such “new” investing invention – stablecoins. Let’s take a look.

A stablecoin is a type of cryptocurrency (ie: a digital currency). This is amongst the most popular/talked about segments of the crypto world at the moment so if you haven’t heard of them already, you likely will soon. Major companies such as Amazon and Walmart are talking about adopting them and major banks such as JP Morgan Chase and Citigroup are exploring launching their own versions of these coins. Further a bill is in front of Congress this week (already passed thru the Senate) to provide a formal framework for the sector.

There is a reason for some excitement, much of which stems from the nature of stablecoins and their potential to reinvent the world of payments and money movements.

A stablecoin is a crypto currency that is pegged against a reference asset (oftentimes the USD). As the name implies, the value of a stablecoin is meant to be stable. If you purchase a stablecoin that is worth $1 USD, the issuer that provided you the stablecoin is meant to retain $1 USD in reserve, so that when you want to cash it in, you can get your $1 USD back without issue.

An NPR podcast used the analogy of chips at a casino. You exchange cash for chips and when you are done gambling, you exchange any remaining chips for cash (at the same exchange rate as you did in the initial exchange).

A stablecoin by itself is not all that interesting – since its value is stable. This is in contrast to other crypto currencies (like Bitcoin) that can rise in value as demand outpaces supply. It’s the idea to use stablecoins as a form of payments that has the potential to make a very large impact.

Right now, the systems of payments and money movements (whether it be credit card payments, wire transfers, ACH transfers, etc) are a bit cumbersome – especially if there are multiple currencies involved. An exchange of stablecoins would remove this friction, time delays, and added costs (big companies like Amazon and Walmart pay considerable interchange fees to credit card processors).

At this moment, the stablecoin market is about $250 billion but it’s growing fast. Citigroup estimates the total amount of stablelcoin outstanding could reach between $1.6 – $3.7 trillion by 2030 (an admittedly wide range but you get the idea!)

This invention is not without risks (of course). Unlike actual fiat currency, these coins are still new and the regulations are still being developed. There are concerns over the custody of the coins and the validity of the claims that reserves are being kept. As of now, when you buy a stablecoin you are trusting that the company selling it to you is actually holding the reserves (so you can get your money back whenever you wish). Stablecoin companies claim to keep reserves in liquid assets (such as treasury bills) but concerns linger as there are no inspections, audits, or examinations at the present moment. Further, given the ease of transfer and lack of regulation/reporting, these assets are being used for illicit activities like drugs and online scams. Lastly, while the current system of payments (like credit cards) may take some time and have associated costs, they provide considerable safety and checks & balances that are lacking from the stablecoin universe at this time.

As you can see, there is a lot to understand about stablecoins – both positive potential and negative characteristics. As always, know what you own and proceed with caution!