What is a Stablecoin, and why should you care

The Retired Investor

What is a Stablecoin, and why should you care?

Stablecoins have become a hot topic lately.  The supply of this digital currency has grown from $2 billion to $200 billion, and it is beginning to transition from the digital to the conventional world of finance. The Senate's passage of the GENIUS Act this month sets the stage for stablecoins to further integrate into the global economy.

A stablecoin for those who have yet to dip their toes into the digital world is a cryptocurrency without the notorious volatility typically associated with that asset class. Their value is generally pegged or tied to that of another currency, such as the U.S. dollar, a commodity like gold, or another financial asset, such as a U.S. Treasury bond or bill.

Stablecoins can act as a medium of exchange. To do so, a stablecoin, like any other currency, must remain relatively stable, assuring those who accept it that it will retain purchasing power in the short term. That is where the need for collateral comes in. 

There are four types of stablecoins, depending on the types of collateral they have chosen. Fiat-collateralized stablecoins maintain a reserve of a fiat currency such as the U.S. dollar or, in some cases, U.S. Treasury debt instruments. As such, stablecoins have become one of the largest holders of U.S. Treasuries in the world. 

Other collateral choices include commodity-backed stablecoins, pegged to the market value of individual commodities such as gold, silver, or oil. Crypto-collateralized stablecoins, backed by cryptocurrencies and algorithmic stablecoins, are computer-driven and strive to keep the stablecoin's value stable by controlling its supply.

Until now, the stablecoin universe has been considered the exclusive domain of crypto enthusiasts who require a digital cash equivalent to finance their trades. The GENIUS Act, short for Guiding and Establishing National Innovation for U.S. Stablecoins, just passed by the Senate, is intended to open this market to the conventional financial world.

The act aims to establish a clear federal framework for stablecoins, introducing strict reserve, licensing, and consumer protection standards. Rather than speculative instruments, the act would treat stablecoins as a payment infrastructure with full reserve backing and monthly audits for issuers to ensure stability and reliability. The legislation now goes to the House, where the act could pass by the end of August.

If the act passes, the benefits will likely first accrue to the crypto investor, who can use these stablecoins as a cash management tool. For example, it could be a place to store their profits from Bitcoin or Ethereum, Solano, etc., without converting those gains back into a fiat currency.  The investor could even receive an interest rate return, as many of these stablecoins now offer annual yields similar to those of money-market mutual funds. If a new opportunity in the crypto universe comes along, he could then use these stablecoins to acquire it with his stablecoins.

If the GENIUS Act becomes law, it would be logical to transition this digital asset into conventional finance. These coins, for example, could be used similarly to debit-card-based payments. In the brave new world of digitalization, stablecoins offer some real advantages.

It all comes down to time and money. In today's conventional transfer of funds between two or more parties, intermediaries charge a fee based on the amount transferred and typically require a waiting period before the transaction is complete. Some sums of money can take days to settle or more or are limited to being transacted only during specific windows of opportunity, such as bank working days.

Blockchain technology eliminates most of that. Stablecoins enable near-instant transfers, improved settlement speeds, and reconciliation of business payments almost instantly. Internal branch-to-branch or book transfers for banks, as well as intercompany settlements, would also be much faster and cheaper than straight money transfers. Many transactions could be significantly less expensive because they bypass intermediaries.

Additionally, stablecoins can utilize contract technology to facilitate automated payments under predefined conditions and events. Real-time transaction tracking would become commonplace, and stablecoins could be used across various platforms, wallets, and networks. A well-regulated digital entity could trigger significant changes in the way money is transferred among governments, banks, merchants, technology platforms, and digital wallets, as well as between traditional and decentralized financial systems.

For consumers, three obvious benefits include online shopping and sending and receiving money internationally, as well as paying utilities, subscription services, rent, and, at some point, even mortgage payments.

There has been a complete turnaround in the government's attitude toward all things crypto, largely thanks to President Trump and his administration. In the case of Stablecoins, the U.S. Treasury has been particularly enthusiastic over the prospect of institutionalizing the acceptance of these coins. Since most stablecoins are pegged to the dollar (over 90%), they help to cement and maintain the dollar's dominant role in the global economy. A growth industry, such as Stablecoins, could also increase the use of U.S. Treasuries as collateral. That would open up a vast new market for our sovereign debt, something that would likely keep long-term bond yields in check for the foreseeable future. In any case, stablecoins are part of the new digital frontier, and I expect to see their use sprout throughout society in the years ahead.

Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Direct your inquiries to Bill at 1-413-347-2401 or email him at billiams1948@gmail.com. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.