The Risks and Rewards of Stablecoin Investing
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Here at Castle, we have received questions from investors lately about investing in so-called “stablecoins,” such as USD Coin (“USDC”), Tether (“USDT”), and Dai (“DAI”). Generally, these virtual currencies seek to maintain a value of approximately $1.00 USD. The mechanisms for maintaining this value vary by coin but rely typically on various incentives designed into their minting, burning, and collateral management processes to keep the value of the coin close to the $1 “peg.” Stablecoins continue to attract investors; for example, the research firm Messari.io reports that the value locked in the USDC stablecoin is up roughly 700% for the seven months ended July 31, 2021. In addition to the custody, valuation, illiquidity, and other risks applicable to any virtual currency investment, we believe that investors considering stablecoin investing should consider, at a minimum, the following questions: Who or what is backing the stablecoin? How difficult is it to convert the stablecoin back to USD or other currencies? ● What drives demand for the coin? Backing Stablecoins: Institutions and Collateral As of July 31, 2021, there are few regulations governing the issuance of stablecoins, including the requirement that each coin issued be “backed” by assets having a value equal to or greater than the number of coins outstanding. However, the market for stablecoin dollars is competitive, and the issuers of USDT and USDC have in recent months been issuing reports showing the value of their “reserves” as of certain dates, as verified by third-party accounting firms. This approach differs from the “decentralized autonomous organization” issuing the DAI stablecoin, which uses a computerized “smart contract” to maintain reserves of various virtual currencies, such as Ethereum and Bitcoin, with a value roughly equal to the number of DAI issued. Following the financial crisis of 2008, which stressed the money-market mutual fund industry, the Securities and Exchange Commission made several rule changes requiring managers of those funds to stress test their portfolio valuations and report the composition of their portfolios timely to the regulator. No such regulations yet exist for stablecoin reserve portfolios. Accordingly, investors should consider carefully whether these reserve assets are sufficient to support the value of the coins in circulation and whether the reserves are invested in a way that could fund substantial liquidations in times of market stress without significant losses. Liquidity and Convertibility Ultimately, the market determines the price of a stablecoin, regardless of the value of the reserve portfolio. In addition to any premium or discount to these reserves, the technology behind the coin (blockchains, lending and staking applications, etc.) can have a significant impact on the returns investors can expect from their stablecoin holdings. When comparing stablecoin

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