The cryptocurrency space has been growing since Bitcoin first emerged in 2009, but there is still a lot of work to be done. One of the offshoots that was created from the introduction of Bitcoin was the stablecoin, which made its first appearance in 2014. Since then, they have gained considerable support and are now an integral part of the ecosystem. Jason Simon, a FinTech and cryptocurrency expert, discusses stablecoins and what they mean to cryptocurrency and traders.

Stablecoins are now more popular with traders and have experienced ten-fold growth in market value in the past three years. However, there is a lot that has to be taken into consideration. A stablecoin is a type of cryptocurrency whose value is tied to an external asset, like the US dollar or gold, that isn’t expected to fluctuate much in value. Bitcoin, Ethereum, Ripple and other cryptocurrencies have a number of benefits, including their use as a fast, cheap payment option. One significant drawback, though, is that their prices can see significant fluctuations. They have a tendency to move up and down, sometimes seeing major movements in a matter of hours.

Stablecoins, such as Tether (USDT), USD Coin (USDC) and others, are backed by assets that are independent of the cryptocurrency ecosystem. These assets are typically not affected by wild price swings, allowing traders to move their cryptocurrency assets to stablecoins when signals of volatility begin to appear. Traders can also move between trades quickly on platforms, while transferring those assets to fiat can sometimes take days. “Traders and investors use stablecoins as a useful hedge in their trading portfolio,” explains Simon. “This trading strategy lowers the risk of purchasing cryptocurrencies, while protecting the value of the trader’s investments.”

While stablecoins are designed to be “stable,” they are only as reliable as the asset to which they are pegged. Although the price of the US dollar is stable, for example, that might change, which would impact the price of any of the US dollar-pegged stablecoins. If the stablecoin reserves are stored with a financial institution or some other third party, outside the control of the issuer, there arises a counterparty risk vulnerability. This means that the issuer may not have the physical collateral to back the stablecoin. This is a problem Tether ran into years ago and it still has not provided a response.

Many stablecoin issuers aren’t transparent about where they hold reserves or how much. This makes it difficult to know how risky the stablecoin as an investment. By knowing where the assets are held, users are able to easily determine if the stablecoin is operating without a license. As has been seen already in cases in Brazil and Canada, financial regulators can seize assets of entities not holding proper licenses, even if those assets are linked to investors. By not revealing how much the stablecoin holds in assets, it’s impossible to know if the platform is solvent. This is ultimately a large drawback to stablecoins that, coupled with their centralized control, make them a less attractive option to most cryptocurrency enthusiasts.