Note4Students

From UPSC perspective, the following things are important :

Prelims level: Stablecoins

Mains level: Read the attached story

stablecoins

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.