Finance Monthly - December 2021

price of an algorithmic stablecoin is pegged to $1 but the stablecoin becomes higher, then the algorithm would release more tokens automatically to bring the price back down. Similarly, if the value drops below $1, then the algorithm would reduce the supply to bring the price up again. The benefits of stablecoin As well as reduced volatility, there are several benefits to stablecoins: • Earn interest: Users can earn more interest on a stablecoin investment than what most traditional banks would offer. • Trade and save assets: A bank account isn’t required to hold stablecoins and they’re typically easy to transfer. Stablecoins’ value can be sent around the world, even to places where the local currency may be unstable. • Affordable money transfers: The transfer fees for stablecoins are typically very affordable. • Transfer internationally: Thanks to the low transaction fees and fast processing, stablecoins can be a great choice for transferring money to different countries. What are the risks of stablecoin? Despite the benefits of stablecoin, there are nonetheless several risks to be aware of: • Counterparty risk: With stablecoins, there is the risk that a bank run could lead to the price of the coin dropping substantially. This is because, by trusting a third party to print money and keep a cryptocurrency stable, there’s the possibility that the dollars could be fractionally reserved rather than being fully backed. • Centralisation risk: A second major risk is that accounts can be blocked, embezzled, or accessed by an unauthorised third party. Centralisation risks also apply to fiat currencies — when a central authority can print money without oversight, a potential consequence is hyperinflation. • Algorithm manipulations: Another major risk to consider is algorithm manipulations. Most decentralised stablecoins live within smart contracts in protocols such as Ethereum. As such, there’s the risk that the algorithm that keeps the currency stable could fail or even be manipulated by a third party. While there are many great benefits to stablecoin, there are also significant risks that need to be thoroughly researched and considered. Additionally, there are also many different issuers of stablecoins, with each offering its own policy and varying degrees of transparency. Stablecoin may be highly appealing, but it’s important to tread as carefully as you would with any other type of investment. “A fiat-backed stablecoin may have greater stability because it is linked to a centralised financial system that has an authority figure, such as a central bank, that can control prices when valuations become volatile.” Finance Monthly. F i nanc i a l Innov a t i on & F i nTech 59