Stablecoins are a class of cryptocurrency pegged to a stable value, such as the U.S. dollar. The market capitalization of stablecoins has swelled to the hundreds of billions of dollars and with it, so has the noise around this relatively new asset class. The stablecoin industry is still in its early days, leading to misunderstanding of how these innovative products operate, the advantages they offer over existing payment rails, and the distinctions among stablecoins currently on the market. 

Here, we will address seven of the biggest misconceptions about stablecoins and get to the truth about these digital assets and how they work.

Misconception #1: All dollar-backed stablecoins are the same

There are many stablecoins in the market and practices can vary from issuer to issuer. Each stablecoin is slightly different and therefore should be evaluated individually. Most crucially, there is a clear distinction between regulated stablecoins and unregulated stablecoins. 

PayPal USD (PYUSD), for example, is the largest regulated stablecoin. It is issued by Paxos Trust Company, which is overseen by a primary prudential regulator – the New York Department of Financial Services (NYDFS). This makes PYUSD different from other popular stablecoins in the market – USDT is issued by Tether, an offshore company without any regulatory oversight, and USDC issuer Circle does not have a primary prudential regulator in the United States, relying on money transmitter licenses in order to operate there. 

Because it is prudentially regulated, Paxos is required by law to always back PYUSD by only U.S. dollars and dollar equivalents. The NYDFS also ensures Paxos adheres to strict risk management standards. Expansion of the token to new blockchains requires pre-approval by the regulator, which also protects consumers’ interests.

Misconception #2: Stablecoins are unreliable because they’re not fully backed by US Dollar

Prudentially regulated stablecoins (like those issued by Paxos) must by law be fully backed at all times by actual, tangible assets – i.e. cash dollars and/or an equivalent interest in U.S. Treasuries. Prudential regulators (NYDFS in New York, MAS in Singapore, FSRA in Abu Dhabi) actively monitor the issuance and backing of Paxos-issued stablecoins. In contrast, unregulated stablecoins have varying practices and standards for dollar backing. The key difference is these issuers are not subject to prudential regulation and therefore are not required by law to follow specific practices. This introduces risk to the user.

Misconception #3: Stablecoins create new dollars

The issuance of a fully backed stablecoin where only the customer can control his or her funds does not increase the total money supply. Stablecoins are simply digital representations of money already in supply. Stablecoin issuers hold dollars in bank accounts in reserve to back those digital representations. Regulated stablecoin issuers like Paxos have no authority to use, lend or fractionalize dollars held in reserve. This restriction ensures that the assets backing the stablecoins remain dedicated to maintaining their value and available for redemption at any time. This is quite different from the riskier business of fractionalizing dollars that banks do through lending – which does increase the money supply.

Misconception #4: Stablecoins are slow

Blockchain is faster, less costly, less prone to error and harder to hack than legacy payments infrastructure due to advances in cryptography. The result is that more people are enabled to use their money without the delays caused by long waiting periods for a bank to settle a check or bank wire – and with greater certainty and lower cost. This benefits the economy by increasing the frequency of transactions and the economic activity of each dollar (velocity) and by ensuring that less of a customer’s dollar is eaten up by the fees. We expect that stablecoins will become faster and easier to use for everyday payments as they become more broadly adopted.

Misconception #5: People can easily lose their money with stablecoins because of the practices of the issuer

Again, this depends upon the issuer as not all issuers are the same. For example, Paxos Trust Company is an NYDFS-regulated limited purpose trust which means it by law must hold stablecoin reserves in segregated, bankruptcy-remote accounts. Keeping customer reserves in segregated, bankruptcy-remote accounts ensures that these funds are not used for other purposes, such as lending. The underlying assets remain intact and dedicated solely to backing the stablecoins. Regulated entities have certain standards for how quickly they must return dollars to customers upon redemption. Unregulated issuers, however, face no expectations around customer protection or redemption.

Misconception #6: There is no current use case for stablecoins

The value proposition for stablecoins isn’t theoretical. The stablecoin market had a total capitalization of more than $160 billion as of mid-year 2024. While they are widely used to fund crypto trading, they are also used for real world payments. For example, PayPal USD (PYUSD), a stablecoin launched in 2023 by PayPal using Paxos infrastructure, was designed specifically to ease friction in digital payments, send money to friends and family, and facilitate remittances and international payments.

Misconception #7: Stablecoins are a vector for financial crime

Stablecoins, utilizing blockchain technology, represent a new model for financial crime monitoring, identification, and prevention. Blockchain technology enables tracking of transactional activity from one wallet to another which, combined with blockchain analytics technology, has proven to be an important tool for law enforcement and enhances compliance efforts. Blockchain technology also enables stablecoin issuers to remotely freeze and seize tokens where required by law – something that could never be done with physical dollar bills associated with illicit activity.

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To learn more about separating fact from fiction when it comes to stablecoins, contact [email protected].