Stablecoins have been around for roughly seven years, but the debate over them has never been as hot as it has been in recent weeks, not only among crypto enthusiasts, but also among regulators and traditional investors.

What is a stablecoin, and how does it work?

Stablecoins are a sort of cryptocurrency whose value is frequently tied to a variety of assets, including government-issued currencies like the US dollar, precious metals like gold, and even other cryptocurrencies.

Issuers have been dealing with different techniques for realising and maintaining the price peg of stablecoins to the underlying assets. USDT (0 percent), USDC (-0.03 percent), BUSD, and GUSD are examples of stablecoins that are backed by reserves whose dollar value is expected to equal the tokens' circulating supply. Others, such as tether gold, which represents one troy fine ounce of gold on a London Good Delivery bar, are backed by tangible goods.

There are also algorithm-powered decentralised stablecoins like as DAI (+0.04 percent) and FEI.

How are stablecoins used? 

Most people traded cryptocurrency against government ("fiat") currencies and other cryptocurrencies before stablecoins became popular. “Spot trading versus stablecoins began to dominate a larger share of trade activity starting in 2017,” according to Pankaj Balani, CEO of crypto derivatives exchange Delta Exchange.

Stablecoins are a faster, less expensive alternative to trade crypto against fiat currencies, providing for more liquidity. They're also less susceptible to market price changes than other cryptocurrencies, according to theory.

Crypto lending also makes use of stablecoins. Depositing USDC in a savings account with Coinbase, one of the firms behind the stablecoin, will earn you a 4% yearly interest rate. The interest rate on USDT deposits might be anywhere from 1.66 percent and 13.5 percent.

There has been a lot of talk regarding stablecoins recently, and it can be overwhelming at times. The following are the three major events taking place right now:

1. Tether is under a cloud

USDT has established itself as the most widely traded cryptocurrency on the market, serving as a backbone for the whole cryptocurrency ecosystem. Bitcoin (BTC, +7.35% ) is used in more than half of all trades.

Tether, the business behind the digital token, has, on the other hand, been beset by regulatory concerns.

The US Justice Department is investigating whether Tether misrepresented the fact that its transactions were tied to cryptocurrency from banks in its early days, according to Bloomberg.

Tether published a response on its website, claiming that the Bloomberg piece was based on "years-old allegations" that were "patently aimed to create clicks." The firm, on the other hand, did not specifically dispute the charges.

Tether's reserves have also caused some investors concern, with some doubting the company's capacity to redeem its tokens in the worst-case scenario. As part of a settlement with the New York Attorney General's office, the business released the breakdown of its reserves in May. According to Tether, nearly half of the reserves are held in “commercial paper,” which is primarily short-term corporate debt, while 13% are held in secured loans and 10% in corporate bonds and precious metals.

Tether's holdings of commercial paper, loans, and corporate bonds are subject to market risk, term risk, and credit risk, said economist Frances Coppola. “If the value of their commercial paper or corporate bonds fell,” Coppla added, “then the value of their tokens in circulation would be less, not $1.”

2. Regulatory  heat

Stablecoins had a total market valuation of $116 billion as of July 26, up nearly fourfold from the start of the year, according to CoinMarketCap.  As the economy has grown, so has the focus of US and other regulators.

Stablecoins are investigated by regulators since they are more to the existing banking system than other forms of cryptocurrencies, according to Alex Svanevik, CEO of crypto analytics firm Nansen. “There is a real possibility that stablecoins will disrupt traditional finance.”

Tether and other stable-value coins were recognised as a risk to the financial system by Eric Rosengren, president of the Federal Reserve Bank of Boston, a month ago, citing concerns about potential disruption to short-term credit markets.

In addition, US Treasury Secretary Janet Yellen indicated that as part of a presidential advisory council, she will look into stablecoin regulation and dangers. Officials from the Treasury Department, Federal Reserve, Securities and Exchange Commission, Commodity Futures Trading Commission, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corp. met shortly after to consider the matter "in light of the rapid growth in digital assets."

Separately, Chairman of the Securities and Exchange Commission Gary Gensler proposed last week that some stablecoins be classified as securities and regulated by his agency.

According to reports, in China, Fan Yifei, a deputy governor of the People's Bank of China (PBOC), claimed that digital currencies tethered to a fiat currency had the bank "very concerned" and "may bring hazards and problems to the world monetary system."

3. Since Circle has gone public, other stablecoin issuers have increased their transparency

Circle, the company behind USDC, the world's second-largest stablecoin, has also been in the news. By combining with Concord Acquisition Corp., a publicly traded special purpose acquisition company, Circle intends to go public (SPAC). The deal would be worth $4.5 billion to the crypto financial services company.

Circle released, for the first time, a breakdown of the assets underlying its stablecoin in its most recent attestation, dated July 16, following CEO Jeremy Allaire's vow to make the firm more open. About 61 percent of the business's tokens are backed by "cash and cash equivalents," or cash and money market funds, according to the corporation. A additional 13% is made up of “Yankee Certificates of Deposit,” which are CDs issued by foreign (non-US) institutions. Treasury bills account for 12%, commercial paper for 9%, and municipal and corporate bonds account for the remainder tokens.

Paxos, another stablecoin issuer, has revealed a breakdown of reserves for its two stablecoins, Paxos standard and the Binance-labeled BUSD, for the first time. As of June 30, 96 percent of the reserves were held in cash and cash equivalents, with only 4% invested in US Treasury notes.

The bottom line: Stablecoins' systemic importance and risk

Some investors are concerned about worst-case scenarios, such as what may happen if stablecoin issuers face enormous redemption requests, because of the systemic role stablecoins play in crypto trading and lending.

Paxos, another stablecoin issuer, has revealed a breakdown of reserves for its two stablecoins, Paxos standard and the Binance-labeled BUSD, for the first time. As of June 30, 96 percent of the reserves were held in cash and cash equivalents, with only 4% invested in US Treasury notes.

The takeaway: Stablecoins’ systemic role, and risk

Some investors are concerned about worst-case scenarios, such as what may happen if stablecoin issuers face enormous redemption requests, because of the systemic role stablecoins play in crypto trading and lending.

The risk could also spread to traditional marketplaces. Stablecoin concerns are possibly "contagious," according to a report released earlier this month by credit ratings firm Fitch. According to Fitch, Tether's commercial paper (CP) holdings were $20.3 billion as of March 31, suggesting that its CP holdings may be larger than most prime money market funds in the United States, Europe, the Middle East, and Africa.

“If a sudden mass redemption of USDT occurred during a period of increased selling pressure in the CP market, it might have an impact on the stability of short-term credit markets, especially if it was associated with higher redemptions of other stablecoins with reserves in similar assets,” according to the rating firm.

According to David Grider, head of digital assets Research at Fundstrat Global Advisors, stablecoins may have an effect on money supply. “Stablecoins allow you to do something quite distinctive,” he explained, “which is to earn interest on both sides of the same dollar.”

The reserved dollars might be lent out in the real economy, while the digital receipts could be lent out in the crypto market and earn interest. In an analyst report, Grider put it this way: "essentially taking the same dollar and lending it twice."