Crypto: Types of stablecoins and how they work

Yahoo Finance Live’s Brad Smith breaks down stablecoins and how they work.

Video transcript

BRIAN CHEUNG: Interest in algorithmic stablecoins is growing among the crypto community, while drawing scrutiny from regulators. Joining us now to explain is Yahoo Finance's Brad Smith. So, Brad, let's back up here. What even is a traditional stablecoin? Explain.

BRAD SMITH: If you ask Gary Gensler, the SEC chair, he'll say that it is a poker chip. But a stablecoin by the proper definition is a type of token that's designed to always carry a fixed value. So these are coins that are less volatile because they are backed either by Fiat currency or even by a commodity that's averse to the price fluctuations often experienced by the most well-known cryptocurrencies.

Fun fact here, we all know about some of the largest coins, Bitcoin and Ethereum, but did you know that the third largest cryptocurrency is actually Tether? And that is actually a stablecoin. Actually, two out of the top five cryptocurrencies are stablecoins, which further illustrates the critical role that stablecoins play in cryptocurrency utilization and transactions. And while Tether is the largest stablecoin, other common tokens pegged to the value of traditional currency are USD coin and even Binance USD. Akiko.

AKIKO FUJITA: So, how does it all work?

BRAD SMITH: So, simple form here. These are types of stablecoins that we're going to take a look at here as Fiat-backed. And there are four main ones that we're going to dive into-- Fiat-backed, crypto-backed, commodity-backed, and algorithmic.

Now, Fiat currency-backed is the most utilized, where the entity, they issue an amount of coins representative of an actual dollar amount that they hold. So think of it this way. $100 million, 100 million stablecoins. In application, though, if you purchase into a stablecoin that's issued or minted by that entity holding the real money, that would allow the purchaser, you, then, to use their coins, their new coins, to exchange with other blockchain-based assets.

So, to the opposite end, if you already own other cryptocurrencies, then those holdings can be converted into stablecoins. And then those stablecoins can be redeemed for real money, cash money, right?

BRIAN CHEUNG: We love that. No, Brad, you mentioned Gary Gensler has described stablecoins as a bit of a poker chip. What have regulators said broadly about this space?

BRAD SMITH: Yeah, that's a great question. So SEC chairman Gary Gensler expects that roughly 80% to 85% of trading and lending on crypto platforms involves stablecoins, per his comments to the Penn Law Capital Markets Association. Further, Acting Comptroller of the Currency, Michael Hsu, paints the picture of the relationship between the holistic cryptocurrency market and stablecoins to be like an upside down pyramid, if you will, roughly $2 trillion of crypto resting on about 80-- or $180 billion, excuse me, of stablecoins.

The US House Financial Services Committee, they held a hearing on stablecoins during February 2022. And members of that committee have already begun discussing a bill which would set rules for circulating stablecoins from an issuer and levels for proportional reserves.

So this would create a serious issue when regulating algorithmic stablecoins because in that case, if the dollar-pegged stablecoin, for an issuer, if it falls below $1, they would rely on a second cryptocurrency to almost manipulate the price of their stablecoin back to $1. And regulators are not a fan of currency manipulation, to say the least. So to this point, Congress's stance on stablecoin issuers should need to receive the same licensing allowances that ensure depository institutions must abide by as well. Guys.

BRIAN CHEUNG: All right, cash rules everything around me-- or coins rule everything around me. [INAUDIBLE], dollar, dollar bills, y'all. Brad Smith, thanks so much.