Note4Students
From UPSC perspective, the following things are important :
Prelims level: Stablecoins
Mains level: Read the attached story
The US Congress (Parliament) has made another attempt to create a legislative framework for the increasingly popular stablecoins, a sort of cryptocurrency that is pegged to a particular commodity or currency.
What are Stablecoins?
- Stablecoins are cryptocurrencies designed to maintain a stable value, typically by being pegged to a stable asset such as the US dollar.
- Investing in stablecoins can help mitigate market volatility because they are less susceptible to price fluctuations than other cryptocurrencies such as Bitcoin or Ethereum or any other.
Types of stablecoins
| Fiat-backed stablecoins |
Backed by reserves of fiat currency held in a bank account or other secure location. Example: Tether (USDT) |
| Commodity-backed stablecoins |
Backed by reserves of a physical commodity, such as gold or silver. Example: PAX Gold (PAXG) |
| Algorithmic stablecoins |
Use algorithms or smart contracts to maintain a stable value. Example: Dai stablecoin (DAI) |
How can Stablecoin mitigate market volatility?
|
Explanation |
| Hedging against volatility |
- Help investors hedge against volatility and reduce their risk exposure.
- Pegged to a stable asset, which can provide a haven during market turbulence.
- If the value of Bitcoin or Ethereum drops suddenly, investors can move their funds into stablecoins to protect their portfolio from further losses.
|
| Greater flexibility in transferring funds |
- Greater flexibility and convenience compared to traditional fiat currencies.
- Quickly and easily transferred between wallets and exchanges, making them ideal for cross-border transactions.
- Investors take advantage of investment opportunities in other markets and avoid currency exchange fees and delays.
|
| Arbitrage trading |
- Used for arbitrage trading, which involves buying an asset in one market and selling it in another market for a higher price.
- As stablecoins are pegged to a stable asset, investors can quickly move funds between exchanges without worrying about price fluctuations, making arbitrage trading easier and potentially more profitable.
|
What are the risks?
|
Explanation |
| Stability of the asset |
- Stablecoins are reliant on the stability of the asset they are pegged to.
- If the value of that asset drops, it can lead to a drop in the stablecoin’s value as well.
- This could result in losses for investors who hold the stablecoin.
|
| Transparency and regulation |
- There are concerns over the transparency and regulation of stablecoin issuers.
- This could result in a loss of trust in the stablecoin and a subsequent drop in its value.
- There is no proper regulation and oversight.
- There is a risk that stablecoin issuers may engage in fraudulent or unethical behaviour, which could lead to losses for investors.
- It is important for investors to carefully assess the reputation and credibility of the stablecoin issuer before investing in a stablecoin.
|
Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get Prelims prep Toolkit!
Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024
Attend Now