Understanding Stablecoins - The Definitive New Zealand Guide

We explain how to buy, use and manage Stablecoins, and outline must-know facts for anyone interested in buying a stablecoin.

Updated 9 October 2024

Introduction:

Stablecoins are emerging as a cornerstone in the evolving world of cryptocurrencies. Unlike their more volatile counterparts like Bitcoin, Ethereum and Ripple, stablecoins are designed to maintain a steady value.
They achieve this stability by being anchored to more stable assets such as fiat currencies (e.g., the US Dollar, Euro) or commodities like gold. This unique feature makes them an attractive option for those seeking the benefits of digital currency without the extreme price fluctuations.
However, they are not without their risks - Terra (UST) was a USD stablecoin that went to zero in a matter of days, as this Coindesk investigation outlines, and we foresee that other stablecoins may get into trouble for various reasons, the most common being a lack of sufficient capital behind the coin and an absence of reserves.

In this guide, we explain stablecoins - how to buy, use and manage them and outline must-know facts for anyone interested in buying a stablecoin. Whether you're an experienced crypto investor or new to cryptocurrencies, this guide is tailored to help you navigate the stablecoin landscape confidently and safely. Our guide covers:

Important - Protecting Yourself from Scams:

Cryptocurrencies are dynamic and continue to evolve, meaning vigilance in every investment aspect is key. Stablecoins, while offering stability, are not immune to the risks of scams and fraudulent activities.
MoneyHub receives regular emails from crypto scam victims (and those in the middle of being scammed) - it's crucial to exercise due diligence when engaging with platforms and services dealing with crypto, including stablecoins. Before making any transaction, you must verify their legitimacy, read reviews, and understand their security measures before proceeding.
If you encounter any suspicious activities or offers that seem too good to be true, read our Bitcoin and Cryptocurrency Scams guide, which has further information about what to do. Reporting crypto scams to Netsafe New Zealand, Internal Affairs, the Police is useful. Still, the reality is the players behind such scams move a lot faster than any government agency and are usually overseas-based. This is why it's critical to rigorously verify the legitimacy of whatever you invest in to avoid being involved in an online scam or fraud.

Warning:

By publishing this guide, we are not recommending or suggesting in any way or form that stablecoins (or cryptocurrencies in general) are a suitable investment.
We published and routinely update this guide to help people decide what's best for them - MoneyHub is conservative, and our publisher, Christopher Walsh, has cryptocurrency and stablecoin investments. We strongly suggest reading this guidance from the FMA before making any investment. Like the FMA, MoneyHub is also cautious.
We present this information in good faith and remain objective at all times. By including this guide in our Investing and Saving section, we do not advocate that cryptocurrency or stablecoins are an investment. We may earn a referral bonus for anyone who clicks on some of the links below. See our Advertising Policy for more details.

Stablecoins Explained

Stablecoins stand as a unique innovation within the cryptocurrency space, offering a bridge between traditional fiat currencies and the new world of digital assets. By pegging their value to more stable assets like the US Dollar, Euro, NZ Dollar, Australian Dollar or gold, stablecoins aim to provide the stability of fiat currencies and the efficiency and security of blockchain technology.

There are three types of Stablecoins:

1. Fiat-Collateralised Stablecoins: These are the most common type of stablecoins, backed one-to-one by traditional currencies held in reserves. Examples include USDC (USD Coin), USDT (Tether) and NZDD. Our review of NZDD explains more.

2. Crypto-Collateralised Stablecoins: These are backed by other cryptocurrencies. They are more complex and use various mechanisms to maintain stability, like over-collateralisation, where the value of the cryptocurrency backing the stablecoin exceeds the value of the stablecoin itself. Examples include:

MakerDAO's DAI: Backed by a mix of other cryptocurrencies like Ethereum (ETH) and Basic Attention Token (BAT), it's held in smart contract vaults. The system uses over-collateralisation to ensure stability. For example, if you want to generate $100 worth of DAI, you might need to lock up around $150 worth of ETH.
DAI maintains its peg to the US Dollar through a complex system of smart contracts and autonomous feedback mechanisms.

Haven's xUSD: xUSD is part of the Haven Protocol, a unique stablecoin as Haven's native cryptocurrency, XHV, backs it. Users can 'burn' XHV to create xUSD and 'mint' XHV from xUSD, with the amount determined by the current exchange rate between XHV and the US Dollar.
This mechanism allows users to switch between a volatile asset (XHV) and a stable one (xUSD) within the Haven ecosystem, aiming to provide stability and privacy.

3. Algorithmic Stablecoins: These do not have any collateral but use an algorithm to control the supply of the issued tokens, expanding or contracting it based on demand, as seen with Terra (UST) before its collapse.

Stablecoins - Understanding the Risks

Despite the name 'stablecoin', every stablecoin comes with its risks. The collapse of Terra (UST) is a reminder of the potential pitfalls and why nothing is ever 'stable'. Our extensive list of risks below is published to help New Zealanders understand the potential downsides for anyone considering stablecoin investment:

1) Collateral Risks:

Fiat-Collateralised Stablecoins: The primary risk lies in the management and solvency of the reserves. If the reserves are mismanaged or become insolvent, the stablecoin can lose its peg. For example, Tether (USDT) faced scrutiny over whether it held sufficient dollar reserves as collateral before collapsing. The risks are significant, which is why it’s essential to do extensive research to see if the stablecoin is backed by fiat and has funds behind it to guarantee the coin - many cryptos don’t.
Crypto-Collateralised Stablecoins: These depend on the value of the underlying crypto assets. A significant drop in the value of the collateral asset can destabilise the stablecoin. For example, the decline in ETH's value impacted DAI's stability during the crypto market crash in March 2020.

2) Regulatory Risks:

The regulatory environment for cryptocurrencies, including stablecoins, is still evolving. Changes in regulations can significantly impact the stability and legality of stablecoin operations, and in early 2023, the SEC planned to focus on stablecoins as outlined in this Reuters article.

3) Counterparty Risks:

This risk is associated with the entity responsible for maintaining the stablecoin's peg. Mismanagement, fraudulent activities, or insolvency of this entity can result in the stablecoin losing its value. Tether, which has faced scrutiny around how much USD it has to back up the value of USDT, invested heavily in cash throughout 2023 to improve stability and solvency, as outlined in this report.

4) Algorithmic Risks:

For algorithmic stablecoins, the risk lies in the design and execution of the underlying algorithm. Flaws or unexpected market conditions can lead to rapid destabilisation, as seen in the Terra (UST) case.

5) Market Liquidity Risks:

In times of market stress, there might be insufficient liquidity for stablecoin holders to exit their positions without impacting the price, particularly for lesser-known or newly launched stablecoins. Certain smaller stablecoins experienced liquidity issues during the March 2020 crypto market crash.

6) Technical Risks:

The blockchain and smart contracts that underpin stablecoins can have vulnerabilities or bugs, leading to potential security breaches or loss of funds.

7) Legal and Compliance Risks:

Depending on the jurisdiction, stablecoins might fall under different legal classifications, affecting how they can be used and traded. An example of this is the Facebook-led Libra (now Diem) project, which faced legal hurdles globally before closing down in 2022.

8) Operational Risks:

Risks related to the operational processes of the stablecoin system, including potential failures in technology, processes, or human error.

9) Redemption Risks:

This risk concerns the ability of stablecoin holders to redeem their tokens for the underlying asset, especially during periods of high demand or crisis. During the 2020 market crash, some stablecoins faced challenges maintaining their peg and redemption.

10) Inflation and Foreign Exchange Risks:

For stablecoins pegged to fiat currencies, there's a risk related to inflation and changes in foreign exchange rates, which can affect their value.

Our view: While stablecoins offer a promising solution to the volatility of traditional cryptocurrencies, it's essential to approach them with a comprehensive understanding of the various risks involved. As this Moody's report makes it clear - stablecoins have so far been unstable. Each type of stablecoin has its unique set of risks; these should be carefully considered in light of your investment strategy and risk tolerance. Diversification can help manage risk, as with any investment, but it's not a guarantee against loss.

Stablecoin Regulation in New Zealand

The Reserve Bank of New Zealand (RBNZ) is intensifying its oversight of stablecoins and crypto assets, responding to public feedback and the potential impact these innovations might have on the financial system and monetary sovereignty.

In June 2023, the RBNZ announced a preference for increased vigilance over immediate regulatory action. Their reasons for doing this stemmed from the need to understand the evolving sector and balance the risks and opportunities it presents. The announcement suggests that as global regulatory frameworks develop for stablecoins, New Zealand will likely take cues for effective stablecoin regulation.

Understanding NZDD - The New Zealand Dollar-Backed Stablecoin

Auckland-based Easy Crypto launched NZDD, a stablecoin pegged one-to-one to the New Zealand dollar, in November 2023. This is the first NZD stablecoin and is reported to be backed one-to-one to the New Zealand dollar, with money held in a local bank account per its audit reports. Our review of NZDD explains more.
Per this RNZ story in November 2023, Easy Crypto launched NZDD to offer a practical option for crypto transactions and international payments and argues it represents a significant step in bridging traditional finance with the digital age.

The Stablecoin Promise and Skepticism: While stablecoins like NZDD offer new possibilities for digital transactions, there is skepticism in the market. As an example, Simplicity's Sam Stubbs pointed out issues such as the absence of interest payments to stablecoin holders and the inherent contradictions in the crypto industry's stance on traditional currencies in a Stuff.co.nz column in November 2023. Such drawbacks are something to be aware of and balance before making any investment decision.

Regulatory and Industry Perspectives: The launch of NZDD and the RBNZ's increased monitoring reflects a complex landscape where innovation, consumer protection, and regulatory clarity intersect. As the industry evolves, the role of stablecoins in New Zealand's financial system remains a subject of active discussion and development. We suggest reading the dedicated NZDD website for further details.

Beyond NZDD, Pay It Now (PIN) in New Zealand have grown the ability to use stablecoins in the real world thanks to their stability in a way that many cryptocurrencies can't enable. For example, PIN offers payments with crypto for credit cards, QR code payments, making payroll and more, as outlined on PIN’s website.

More details: Our review of NZDD explains more.

Popular Stablecoins

This list provides a closer look at some of the well-known stablecoins in the cryptocurrency market. Remember, the inclusion of these stablecoins does not constitute an endorsement or investment recommendation, and we have not included NZDD as our focus is on international stablecoins. Our goal is to inform you about their features and functionalities. Our review of NZDD explains more about this specific NZD stablecoin.

Tether (USDT):

Tether is one of the most widely used stablecoins, pegged to the US Dollar.
It operates on various blockchains, including Bitcoin (via the Omni Layer), Ethereum, and TRON.
Despite its popularity, Tether has faced scrutiny regarding the transparency of its reserve holdings.

USD Coin (USDC):

USD Coin is a stablecoin pegged to the US Dollar, known for its transparency and regulatory compliance.
Circle and Coinbase issue USDC, operating primarily on the Ethereum blockchain.
USDC is widely regarded for its full backing by reserve assets audited by independent firms.

Binance USD (BUSD):

Binance USD is a USD-pegged stablecoin jointly issued by the cryptocurrency exchange Binance and Paxos, a regulated financial institution.
It's approved and regulated by the New York State Department of Financial Services.
BUSD aims to combine the US Dollar's stability with the efficiency of blockchain technology.

Dai (DAI):

Dai is a crypto-collateralised stablecoin maintained by the MakerDAO system on the Ethereum blockchain.
Unlike other stablecoins, DAI is backed by a mix of other cryptocurrencies rather than fiat currency.
It maintains its peg through a system of smart contracts and decentralised governance.

Paxos Standard (PAX):

Paxos Standard is a fiat-collateralised stablecoin, allowing users to transact with the stability of the US Dollar on the blockchain.
It's issued by Paxos Trust Company and is regulated by the New York State Department of Financial Services.
PAX is known for its high level of regulatory compliance and consumer protection standards.

Know This: Each of these stablecoins brings unique aspects to the table, from their backing assets to the blockchain technologies they operate on. Understanding their differences is critical to navigating the stablecoin market and making informed decisions based on your investment needs and preferences.

How to Choose a Stablecoin

Selecting the right stablecoin requires careful consideration of various factors. However, the most important question is “why do you want to use a Stablecoin?” By answering this question first, you have more of an idea what stablecoin is appropriate for you needs. Important considerations include:

The Issuer’s Backing and Transparency: Evaluate what assets back the stablecoin. Is it fiat currency, cryptocurrency, or a combination of both? Look for stablecoins that provide clear, transparent information about their reserves. Reliable stablecoins often have their reserve holdings audited by reputable firms and publish the results regularly.
The Issuer's Reputation and Track Record: Research the reputation of the issuer's issuer. How long have they been in the market, and what is their track record? Consider if the issuer has faced any legal issues or controversies. The stability and reliability of a stablecoin are closely tied to the credibility of its issuer.
Regulatory Compliance: Determine if the stablecoin complies with its operating jurisdictions' regulatory standards; compliance indicates higher security and legitimacy. Stablecoins regulated by financial authorities (like the New York State Department of Financial Services) often offer more assurance regarding legal compliance and consumer protection.
Technology and Security: Assess the blockchain technology behind the stablecoin. Is it built on a secure, well-established platform like Ethereum? Security measures and protocols are vital. Ensure the technology used minimises risks of hacking and fraud.
Liquidity and Market Presence: A stablecoin's liquidity is crucial, especially if you plan to convert to fiat or other cryptocurrencies. More popular stablecoins generally offer better liquidity. Check the stablecoin's presence in major cryptocurrency exchanges. Wider available coins indicate greater acceptance and ease of transaction.
Use Cases and Functionality: Consider what you want to use the stablecoin for. Are you looking for a safe haven against cryptocurrency volatility or need it for specific transactions like trading or remittances? Who is the firm backing the coin? Is it a legitimate organisation which a track record? Some stablecoins offer additional functionalities, like integrating DeFi platforms or earning interest in staking programs.
Community and Ecosystem: Look into the community and ecosystem surrounding the stablecoin. A strong, active community can signify a stable and well-supported asset. Investigate the partnerships and projects associated with the stablecoin. These can provide insights into its long-term viability and potential for growth.
Fees and Accessibility: Understand the fee structure for transactions, conversions, and other associated costs. Lower fees can make a significant difference in the long run. Check for user-friendly access, including availability on different exchanges and compatibility with popular wallets.

Overall, stablecoins are not without their risks and have been unstable, as outlined by this Moody's report published in October 2023.

Frequently Asked Questions About Stablecoins

Stablecoins aren't commonly understood; our FAQs below are published to help build knowledge. However, regulation and market conditions around crypto are volatile and we strongly make sure you understand where your money is going before making any investment.

What Are Stablecoins Used For?

Stablecoins are used for various purposes, including digital transactions, as a hedge against cryptocurrency volatility, for international remittances, and increasingly in decentralised finance (DeFi) applications. Pay It Now is an example of a New Zealand platform helping to transact and exchange value across different platforms and currencies.

How Safe Are Stablecoins?

The safety of stablecoins depends on various factors, including the credibility of their issuers, regulatory compliance, and the backing assets. However, as with any investment, there are risks involved.

Can Stablecoins Lose Their Peg?

Yes, stablecoins can lose their peg to the underlying asset, especially in cases of mismanagement, regulatory changes, or severe market conditions, as seen with Terra (UST).

Are Stablecoins Regulated in New Zealand?

Not yet, but the regulatory landscape for stablecoins in New Zealand is evolving. The RBNZ is monitoring this space, and regulations may be developed as the market matures.

How Do I Buy Stablecoins in New Zealand?

Stablecoins can be purchased locally and internationally on various cryptocurrency exchanges, like Easy Crypto. Ensure the platform is reputable and complies with local regulations - MoneyHub receives countless emails about everyday New Zealanders scammed by fake platforms that steal money, crypto and/or both.

Can I Earn Interest on Stablecoins?

Some platforms and DeFi applications offer interest on stablecoin deposits. However, it's important to understand the risks and the platform's credibility before investing, as interest won't be paid if the stablecoin collapses.

How Do I Store Stablecoins Safely?

Stablecoins can be stored in digital wallets. For enhanced security, consider using hardware wallets or wallets provided by reputable and regulated crypto platforms.

Are There NZD-Pegged Stablecoins?

Yes - NZDD is a New Zealand Dollar-pegged stablecoin launched by Auckland-based Easy Crypto, providing a local option for stablecoin transactions. Our review of NZDD explains more.

Stablecoins - Our Conclusion

Stablecoins, serving as a bridge between traditional and digital finance, offer New Zealanders and global investors an innovative medium for transactions, investments, and value storage. However, this potential is not without its complexities and risks.
The world of stablecoins is one of rapid innovation alongside significant uncertainties. While they provide an avenue to limit the volatility often associated with cryptocurrencies like Bitcoin and Ethereum, stablecoins introduce their own set of challenges and considerations.
The landscape is evolving; from the regulatory vigilance of institutions like the RBNZ to the pioneering efforts of local entities like Easy Crypto with NZDD. As stablecoins continue to gain traction, their future in New Zealand's financial ecosystem appears promising yet unpredictable. The growth of NZDD and the interest of regulatory bodies in New Zealand and overseas signals a shift towards more structured and perhaps safer stablecoin usage.
However, the approach towards stablecoins should be one of cautious optimism. The lessons from past incidents, like the fall of Terra (UST), serve as a reminder of the inherent risks in seemingly stable digital assets.
If you're considering diving into the world of stablecoins, we encourage potential investors and users to weigh the benefits against the risks, consider the broader implications of their choices, and contribute to a well-informed and responsible stablecoin community to stay up-to-date as developments in cryptocurrency continue at a rapid pace.

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