How Do Stablecoins Work?

As with any emerging asset class, cryptocurrencies are susceptible to market forces. Many crypto projects actively explore ways to reduce risk and bolster participation in the broader crypto ecosystem.

Current solutions extend beyond the buy, sell, and stop orders of conventional markets. Instead, price stability is built directly into the assets themselves. The result is an entirely new subset of the cryptocurrency market known as stablecoins. These tokens are designed for stability.

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Stablecoins connect digital assets to something more stable, like the SGD. For instance, a stablecoin pegged to the SGD aims to track the value of SGD 1. This stability stems from holding an equivalent amount of the underlying asset in reserve, with regular audits ensuring transparency.

The Monetary Authority of Singapore (MAS) has introduced a stablecoin regulatory framework for single-currency stablecoins, issued in Singapore and pegged to either the Singapore dollar or one of the G10 currencies. Issuers must satisfy specific requirements regarding capital, redemption, value stability, and disclosure. 

What Are the Benefits of Stablecoins?

Stablecoins have a handful of key advantages, and keeping these in mind can help you make more informed decisions.

Transaction Speed

Consider the difference in settlement time between traditional bank transfers and stablecoin transactions. While bank transfers can take days to process, stablecoin transfers typically settle within seconds, making them an attractive option for quick, efficient movements of value.

User Access Globally

Stablecoins are rapidly emerging as a preferred solution for international money transfers in remittance-dependent countries across Southeast Asia. They offer a faster and more efficient alternative to traditional cash and legacy systems, largely due to their decentralised design, which allows them to operate outside conventional banking frameworks. Such transfers are vital for many developing economies, where money sent home constitutes a.

Platform Friendly and Flexible

Stablecoins can be used on a wide variety of platforms and exchanged quickly. Simply connect your wallet to an exchange and purchase stablecoins. There’s a lot of flexibility with stablecoins, and they can be bought in some ways, including by making a bank transfer or using a crypto credit card, for example.

Security

How safe and secure are stablecoins? Believe it or not, stablecoins offer higher security than other types of payments, and they offer the benefit of more privacy than other types of payment, as well. And for peace of mind, stablecoins are typically backed by a fiat currency. 

However, even within a regulated environment, individual investors and businesses should choose exchanges that prioritise security. In Singapore, reputable platforms are typically licensed under the Payment Services Act and must adhere to strict anti-money laundering and combating the financing of terrorism (AML/CFT) standards. Gemini, for example, demonstrates this commitment through its In-Principle Approval (IPA) from the Monetary Authority of Singapore (MAS).

Low Transaction Fees

Everyone wants low transaction fees, and this is a common complaint with traditional banks. Have you ever sent money overseas? The cost can be very high, which makes stablecoins an affordable option for money transfers to other countries.

So, how are stablecoins cheaper? Stablecoins take out “the middle man.” Using blockchain technology, stablecoin uses a direct transaction approach, resulting in low transaction fees.

What Are the Risks of Stablecoins?

All of this said, it’s also important to stay mindful of some potential drawbacks. Here’s what you need to know.

Be Mindful of Reserve Management

Stablecoins are only as stable as the management of the reserve. Although stablecoins are less risky than many other cryptocurrencies, look out for a lack of transparency and be wary of any history of fraudulent behaviour on behalf of the issuer, as this can affect the stability, which is the main attribute of stablecoins.

The 2022 Terra/UST collapse from crypto markets, highlighting the global liquidity risks associated with stablecoins. In response, MAS implemented a regulatory framework establishing clear standards for stablecoin issuers, with a focus on value stability,  fully backed and transparent reserves, regular audits, consumer protection, and overall market integrity.

Centralisation Concerns

Due to the nature of stablecoins, control is centralised, which has its pros and cons, but the risk is in making sure the issuer is trustworthy and has enough reserves on an ongoing basis. 

De-Pegging

One or more events, including price fluctuations, could cause stablecoins to drop below a target value, otherwise known as de-pegging. De-pegging can cause a domino effect and impact values at a more systematic level, or it can be isolated to de-pegging an individual investment. 

Any investment has both benefits and risks involved. The key is to do your research and understand your objectives and how you will use the investment. 

What To Know About Stablecoins and Use Cases

To understand the purpose of stablecoins, it helps to first look at the appeal of other cryptocurrencies like  Bitcoin. Part of the rising popularity stemmed from a lack of trust in central banks and the desire and need for efficiency. 

These factors, among others, have put Bitcoin on the investment map, appealing to both new and seasoned investors. However, its inherent volatility and price swings are often viewed as drawbacks, which is precisely what led to the rise of stablecoins.

Their stable value associated with Bitcoin has made them a viable alternative to other cryptocurrencies. However, Bitcoin's uncertainty and volatility have made the digital asset less attractive for some transactions. 

So, what are stablecoins used for?

Stablecoin Use Cases

Several main use cases generally stand out for stablecoins and contribute to their growing popularity. The first is buying and selling crypto assets, because stablecoins are pegged to another currency or commodity.

Stablecoins play a critical role in trading and decentralised finance (DeFi), allowing investors to manage their crypto positions without constantly converting to fiat. They also serve as reliable collateral for borrowing, lending, and earning yields within the digital asset ecosystem.

Another use case for stablecoins is also one of the main benefits mentioned earlier. It’s the ability to execute cross-border payments efficiently, with the reassurance of less volatility than cryptocurrency. Due to the nature of stablecoins and other cryptocurrencies, this type of payment can be made at any time, without reliance on banking hours. For example, a migrant domestic worker in Singapore . 

Stablecoin Taxonomy

Stablecoins are digital currencies minted on the blockchain network that are typically identifiable by one of four underlying collateral structures: fiat-backed, crypto-backed, commodity-backed, or algorithmic. While underlying collateral structures can vary, stablecoins aim for the same goal: stability. 

Let’s discuss the four primary types of stablecoins.

Traditional Collateral (Off-Chain)

The most popular stablecoins are backed 1:1 by fiat currency. Because the underlying collateral isn’t another cryptocurrency, this type of stablecoin is considered an off-chain asset. Fiat collateral remains in reserve with a central issuer or financial institution and must remain proportionate to the number of stablecoin tokens in circulation.

For example, if an issuer has USD 10 million in fiat currency, it can only distribute USD 10 million in stablecoins, each worth one dollar. 

Some of the biggest stablecoins in this category by market value include:

• Tether (USDT)

• Gemini Dollar (GUSD)

• USD Coin (USDC)

• True USD (TUSD)

• Paxos Standard (PAX)

Crypto Collateral (On-Chain)

As the name implies, crypto-collateralised stablecoins are backed by another cryptocurrency as collateral. This process occurs on-chain and employs smart contracts instead of relying on a central stablecoin issuer. 

When purchasing crypto-backed stablecoins, you lock your cryptocurrency into a smart contract to obtain tokens of equal representative value. You can then put your stablecoin back into the same smart contract to withdraw your original collateral amount. DAI is the most prominent stablecoin in this category that uses this mechanism. This is realised by utilising a collateralised debt position (CDP) via MakerDAO to secure assets as collateral on the blockchain.

Crypto-collateralised stablecoins are also over-collateralised to buffer against price fluctuations in the required cryptocurrency collateral asset. To provide a real-world example: If you want to buy USD 1,000 worth of DAI stablecoins, you would need to deposit USD 2,000 worth of Ethereum (ETH) — this equates to a 200% collateralised ratio. 

If the market price of ETH drops but remains above a set threshold, the excess collateral buffers DAI’s price to maintain stability. However, if the ETH price drops below a predetermined threshold, the collateral is paid back into the smart contract, allowing the CDP to be liquidated.

Algorithmic Stablecoins

Algorithmic stablecoins do not use fiat or cryptocurrency as collateral. Instead, their price stability results from using specialised algorithms and smart contracts that manage the supply of tokens in circulation. An algorithmic stablecoin system will reduce the number of tokens in circulation when the market price falls below the price of the fiat currency it tracks. 

Alternatively, if the token price exceeds the price of the fiat currency it tracks, new tokens enter into circulation to adjust the stablecoin value downward.

Commodity-Backed Stablecoins

Commodity-backed stablecoins are collateralised using physical assets like precious metals, oil, and real estate. The most popular commodity to be collateralised is gold; Tether Gold (XAUT) and Paxos Gold (PAXG) are two of the most liquid gold-backed stablecoins.

However, it’s important to remember that these commodities can, and are more likely to, fluctuate in price and, therefore, have the potential to lose value.

Commodity-backed stablecoins facilitate investments in assets that may otherwise be out of reach locally. For instance, obtaining a gold bar and finding a secure storage location in many regions is complex and expensive. As a result, holding physical commodities like gold and silver isn’t always a realistic proposition. 

Commodity-backed stablecoins also afford utility to those who want to exchange tokens for cash or acquire the underlying tokenised asset. Holders of Paxos Gold (PAXG) stablecoins can sell them for cash or acquire the underlying gold. 

However, because London Good Delivery gold bars range from 370 to 430 per ounce, and each token represents one ounce, users must hold a minimum of 430 PAXG to execute token redemption. Once redeemed, token holders can take possession of their gold at vaults throughout the UK.

Similarly, holders of Tether Gold can redeem XAUT tokens in exchange for physical gold if they complete the TG Commodities Limited verification process and hold a minimum of 430 XAUT. This minimum reflects the standard 430 oz London Bullion Market Association (LBMA) gold bar. Once XAUT is redeemed, holders can take possession of their gold at a location they choose within Switzerland. 

Although the ability to redeem gold-backed stablecoins for physical gold is universal across active platforms, other commodity-backed stablecoins lack the same utility. For example, Venezuela's exploratory Petro stablecoin isn’t redeemable for a barrel of oil. While stablecoins backed by other commodities like real estate have made headlines in recent years, a lack of active projects makes it difficult to draw further comparisons.

In contrast, asset tokenisation continues to generate interest in a closely related market segment. Similar to commodity-backed stablecoins, tokenised assets are valued from external, tradable assets like gold.

Medium of Exchange and Store of Value

The most immediately apparent advantage of stablecoin technology is its utility as a medium of exchange, effectively bridging the gap between fiat and cryptocurrency. By minimising price volatility, stablecoins can achieve a utility that is wholly separate from the ownership of legacy cryptocurrencies.

As their name suggests, stablecoins are inherently stable assets. This makes them suitable stores of value and encourages their use in everyday transactions. Further, stablecoins improve the mobility of crypto assets throughout the ecosystem.

Stablecoins point toward integrating traditional financial systems with the quickly evolving decentralised finance (DeFi) industry. As a force for market stability, stablecoins present a primary vehicle for cryptocurrency adoption in loan and credit markets while inheriting much of the utility previously reserved for only fiat currency.

Stablecoins are gaining popularity due to their low costs, ease of use, access, and flexibility. This type of cryptocurrency is tied to a different kind of currency, so it’s less vulnerable to market volatility overall. Start building your portfolio today with Gemini.

In Singapore, investors generally do not pay . This includes stablecoin trades, unless such activities are frequent enough to be considered a business. Learn more about the Inland Revenue Authority of Singapore’s (IRAS) tax framework from this guide.

Stablecoins and Regulation in Singapore

The Monetary Authority of Singapore (MAS) actively evolves Singapore’s digital asset landscape, thanks to initiatives like , which explores the potential of institutional DeFi. With the introduction of a new framework for MAS-regulated single-currency stablecoins (SCS), Singapore further solidifies its position as a secure, crypto-friendly hub. 

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