Should You Invest in Stablecoins?

A stablecoin Is a cryptocurrency designed to match the value of an ordinary currency such as the U.S. dollar or the euro. There are many stablecoins on the market today, and the largest ones are the most heavily traded names in the crypto sector. That doesn't necessarily make them a good investment, but owning some high-quality stablecoins may make sense in some situations.

The leading stablecoins

Here are the five largest stablecoins today, as measured by total market value:

Data source: Coinmarketcap.com on 4/28/2022. Chart by author.

All of these stablecoins are pinned to the U.S. dollar. Their prices tend to stay within a rounding error from $1 per coin. Anything else is an aberration and quite possibly a cause for concern.

Here's how three of these stablecoins have performed over the last two years. Their prices rarely stray more than $0.01 away from the value of a single dollar, and they're only becoming less volatile over time:

Tether Price data by YCharts.

What's the difference between these dollar-based stablecoins?

Various stablecoins achieve similar results in different ways. Some of them are backed by actual cash or cash-like assets. For example, Tether holds cash reserves, commercial paper, treasury bills, and other dollar-based valuables.

Whenever the Tether Operations company issues or burns Tether tokens, it adds or removes an equal amount of cash-like assets from the corresponding value reserves.

Similarly, Circle and Coinbase stock up the USD Coin's cash reserves with a simpler mix of Treasury bonds and actual cash.

Taking the simplification one step further, the Paxos Trust Company ensures that the Binance USD coin's market value always is matched by a dollar-based bank account of the same size.

Dai and TerraUSD are a bit different. Dai backs its stable value through a portfolio of cryptocurrencies, automatically managed through smart contracts.

TerraUSD is marketed as a more scalable stablecoin, created by burning Terra (LUNC -1.29%) tokens and backed by holdings in interest-bearing proof-of-stake cryptocurrencies. It's no surprise that these solutions are slightly more volatile than their cash-backed brethren, but the difference is negligible.

Why would anyone buy a stablecoin?

First of all, you may have bought and sold some stablecoins without even knowing it. Let's say you picked up a fraction of a Bitcoin token or maybe some Ethereum on the Coinbase platform. The money you transferred from an ordinary bank account was briefly converted into USD Coin, which was then exchanged for the desired amount of Ethereum or Bitcoin.

The Binance trading platform does the same thing, using Binance USD coins instead of USD Coin. Stablecoins serve as a fast-moving liquidity base for the trading platforms.

That's not the only reason to hold some stablecoins in your crypto portfolio. Web3 applications, such as blockchain-based gaming and decentralized finance tools, may find stablecoins useful for managing each user's bets, investments, cash deposits, and more.

Image source: Getty Images.

We still haven't reached the end of the list. Under certain circumstances, it can make sense to buy and hold stablecoins like you would hold cash in a traditional bank's savings and money market accounts.

• Many stablecoins can generate passive income, with annual interest rates ranging between 3% and 20%.
• In times of extreme volatility in other cryptocurrencies, you can convert some or all of your crypto holdings into the trading-platform's preferred stablecoin -- without trading anything against actual cash. This can be a tax-efficient way to manage your exposure to volatile crypto tickers.

If you're looking for a safe haven in the stormy seas of cryptocurrency investments, stablecoins can give you peace of mind and predictable interest rates. I don't know about you, but I'd rather put some of my long-term savings in a TerraUSD wallet with a 20% interest rate than a savings account yielding less than 1% a year. That's a new way to keep inflation at bay.