Stablecoins have provided many investors with the long-awaited utility function. But, putting all your eggs in the stablecoin basket is not without its hazards. In the case of a novel financial instrument, no matter how “stable” it may seem, there is no cure or elixir that can eliminate all potential dangers and concerns. Stablecoins, after all, aren’t exactly novel. They may be a breath of new air in the otherwise stale world of finance, but most digital currencies are just fiat currencies stored on mobile devices or online wallets. This is why we feel it’s important to draw attention to some of the potential pitfalls of investing in stablecoins.

Potential Risk of Stablecoins

This is highly crucial for investors to be aware of a few risks that stablecoins have before putting in money.

1.    Problems with Economic Stability and Inflation

We know from experience that governments aren’t always the most fiscally savvy entities and that their policies may lead to currency collapses and widespread price increases. To put it simply, there is a reason why most stablecoins are tied to the United States dollar or the Euro rather than the Argentine peso. This is due to the fact that the US dollar, and by extension the US Treasury, has an air of reliability that has persisted for at least the last half a century. If stablecoins were released in a poorly managed fiat currency, nobody would trade their existing currency for them, rendering the stablecoin worthless due to a lack of liquidity. On the other hand, this leaves your stablecoins vulnerable to inflationary global black swan occurrences.

2.    Problems Arising from Inadequate Regulations

Concerning rules and regulations, two basic problems exist. The G7 meeting clearly proclaimed the major hazards inherent in adopting stablecoins as international settlements as 2019 came to a close. Money laundering, tax evasion, and terrorist funding accounted for the bulk of these dangers. There is validity to the comments, even though one might argue that the legacy financial systems are too dependent on conventional banks and their fees to accept stablecoins. Like other digital currencies, the criminal underground has challenges when dealing with stablecoins. Cryptocurrency is far more convenient than bank checks for paying a weapons dealer. Stablecoins compound this threat since their values are more or less fixed, unlike those of altcoins, which means they are more likely to be used in illicit transactions. Since most stablecoins are issued by centralized businesses that are also responsible for maintaining their reserve, the value of the stablecoin may be influenced if the issuer experiences financial problems or goes bankrupt, potentially resulting in a loss of money for the holders.

3.    The Risk of Currency Replacement

Stablecoins might threaten emerging markets by replacing local currencies if they gain widespread use. People may choose to keep stablecoins rather than native currency if such stablecoins are tied to conventional fiat currencies, which might lead to a devaluation of the local currency and a flight of capital out of the nation. This may make it harder for the central bank to control the domestic economy and diminish monetary sovereignty.

4.    Difficulties in managing interest rates and liquidity at home

When stablecoins enter circulation in an EMDE, the central bank may find it more difficult to manage domestic interest rates and liquidity. Stablecoins, which operate independently of central banks, may draw deposits and investments, decreasing the efficacy of monetary policy instruments. Stimulating economic development and maintaining financial stability might be made more difficult by this lack of control. However, people still invest in digital currencies and stablecoins with the help of auto bots such as Bitcoin Bank to trade them with ease.

5.    Avoiding controls intended to regulate cash flow

Capital flow management is a set of policies and procedures used by developing economies to control the influx and outflow of money. Stablecoins, on the other hand, are enticing tools for evading these restrictions since they are decentralized, borderless, and pseudonymous. Bypassing capital regulations using stablecoins might lead to uncontrolled capital flows, more volatility, and difficulty in preserving financial system stability.

6.    Disruption of credit risk evaluation and capital formation

Credit risk assessment might be harmed by the use of stablecoins, which could reduce the ability of financial institutions to obtain funds and provide loans. If consumers and companies choose to keep their money in stablecoins rather than traditional banks, this might limit the bank’s ability to raise funds. As a result, they may be unable to lend as freely, which might impede the development of the economy over the long run.

7.    Potential for illegal activity to rise

The anonymity afforded by stablecoins increases the risk that monetary transactions may be misappropriated. Lack of transparency and the inability to track these activities effectively might make it easier for criminals to do acts like money laundering and the financing of terrorism. Developing nations currently facing these challenges may be put at even greater risk if stablecoins are widely embraced without adequate legal structures.

Bottom Line

Although there are certain advantages to stablecoins in terms of accessibility and stability, there are potential risks that investors should know. Because this is the matter of your hard-earned money, you should not put all your eggs in stablecoin basket.