What’s in a name? That’s a good question to ask when it comes to stablecoins. Despite their name, these crypto assets can be very volatile and not stable. There have been several instances where crypto assets that claim to be “stablecoins” did not maintain their “peg” on trading platforms. Find out more about “stablecoins” and why value-referenced crypto assets is a better term.
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What is a stablecoin?
You may have heard the term stablecoin to refer to a type of crypto asset. There is no official definition of what a “stablecoin” is. The term can be misleading since “stable” does not adequately reflect how volatile these crypto assets can be.
There have been many instances where the value of so-called “stablecoins” was extremely volatile and where their value was significantly reduced. A more accurate term to use is value-referenced crypto asset (VRCA). VRCAs are subject to various risks and are not the same as fiat currency (e.g., Canadian dollars).
What is a value-referenced crypto asset?
A value-referenced crypto asset (VRCA) is designed and promoted to maintain a consistent value over time by being pegged to a reference value.
The most common VRCAs are fiat-backed crypto assets. They are intended to replicate the value of a single fiat currency, for example, the Canadian dollar or US dollar. And they are often marketed as being backed by cash or cash equivalents, like short-term government debt.
Although the issuers of fiat-backed crypto assets often claim that their VRCAs are backed by cash or cash equivalents, a key risk associated with VRCAs is the lack of public information about what is actually backing the VRCA. There can also be a lack of independent verification of what is backing the VRCA.
If you own this type of crypto asset, you might think it would maintain its value against the currency it is pegged to. But the value of any fiat-backed crypto asset can fluctuate. And it can lose its peg to the fiat currency.
Other VRCAs may be pegged to assets such as gold or other crypto assets. Or a VRCA could be pegged to a basket of assets (such as a basket of fiat currencies or a basket of crypto assets).
There are also VRCAs that attempt to maintain their value based on an algorithm. Algorithmic VRCAs are generally riskier than other types of VRCAs. Algorithmic VRCAs may not be backed by assets and rely on algorithms and market incentives to adjust their value to maintain their peg to a reference asset. However, even those VRCAs that are backed by assets on a 1:1 basis may not maintain their peg to the reference value.
If you are considering purchasing a VRCA, you should know you’re relying on the effectiveness of:
- A stabilization mechanism – That mechanism is supposed maintain the VRCA’s peg. This could be a reserve of assets or an algorithm.
- The efforts, conduct and integrity of the people who design, implement and oversee the operation of that mechanism. This may include the issuer of the VRCA or others.
If someone is selling you a VRCA, you should always check the registration of the person or company you are dealing with.
There are several crypto trading platforms that have taken steps to be registered in Canada. These platforms are subject to regulatory requirements that helps protect investors. If you are considering investing in crypto assets, including VRCAs, always work with a registered crypto asset trading platform. Importantly, all crypto assets, including VRCAs, carry risk, even if they are available on a registered crypto trading platform. Canadian securities regulators do not approve VRCAs, endorse their safety, or ensure they are compliant with Canadian securities laws.
What are the risks of investing in value-referenced crypto assets?
Crypto assets are high risk. Purchasing crypto assets is a speculative activity and their value and liquidity are highly volatile. Crypto assets may not be suitable you.
The risks of VRCAs include:
- Transparency – It is not always clear what the VRCA arrangements are. You may not know its asset reserves, its stabilization mechanism, or its governance. If you hold VRCAs, you may not receive important information about the issuer or key features of the VRCA. That means you may not know your rights and risks when trading these assets. VRCA issuers typically do not provide information regarding their operations or financial condition that is comparable to the information required for public companies. And any information that is provided is generally not subject to meaningful regulatory oversight or standards.
- Risk level – You may be misled into believing VRCAs are risk-free or a safe form of cash equivalent. This is not true. Depending on the nature of the VRCA and the VRCA issuer, a VRCA can be high risk. Holding a fiat-backed VRCA is not the same as holding fiat currency in a deposit account with a Canadian financial institution or a registered dealer. You may think the price will not deviate from its reference value (both in the normal markets and during difficult events), but this is not the case.
- Redemption rights – Some VRCAs may claim to be redeemable or exchangeable for the equivalent amount of the reference currency. However, these rights do not apply to everyone who has the VCRA. You should be aware that the redemption rights on VRCAs are left to the discretion of the issuer and are not always clearly disclosed. You may not be able to redeem a VRCA directly with the issuer and must sell your position through a crypto asset trading platform. This means that you will only be able to sell it at the price that someone else is willing to pay for it, which may be significantly less than the value of the reference asset.
- Stability – VRCAs may not be a stable investment. This is because the stability of the value of the VRCA depends on the effectiveness of the stabilization mechanism. This includes its ability to maintain its peg to the VRCA’s reference asset, the management of the mechanism, the custodianship of its reserve of assets and its governance (including associated conflicts of interest). There is also the possibility of a redemption risk or “run” risk. If everyone decides to redeem their VRCAs, the value of your asset could be substantially reduced or wiped out.
- Solvency risk – Even with sufficient reserves of assets, perceived solvency concerns with the issuer, the custodian or a related entity could cause the VRCA to de-peg. This means your investment may end up losing its value. Also, if the VRCA issuer becomes insolvent or bankrupt, there is a risk that any reserve of assets could be subject to claims of creditors of the VRCA issuer.
- Unclear allocation of liability and ability to obtain redress – It may be difficult for you to determine who is responsible for any losses or get your money back.
- Cybersecurity and technology related risks – There is a chance your VRCA holdings could be hacked, or other online security issues could emerge.
- Advertising or marketing practices using digital engagement practices – You may be targeted and misled as to the level of risk and nature of the VRCA.
- Non-compliance with securities laws – Many VRCAs may be securities and/or derivatives and are generally not offered in compliance with securities laws, which increases the risk to purchasers.
The risks of investing in any crypto asset include:
- High volatility – Crypto assets are prone to large swings in market value, gaining or losing hundreds or even thousands of dollars over the course of a day. This makes holding crypto assets risky. The crypto assets you own could lose some or all of their market value at any time.
- Unregistered entities – Many crypto asset trading platforms (CTPs) have not complied with regulations and therefore are not registered. Registered firms are subject to regulatory requirements that aim to protect investors. View the list of crypto asset trading platforms that are registered in Ontario.
- Terms and conditions – You typically agree to terms and conditions when you sign up for a crypto trading platform. These are usually written by the service provider and may be not in your best interests. For example, the terms and conditions may or may not transfer property rights in the crypto asset to the service provider. Carefully review the terms and conditions associated with any crypto trading platform or other party that you use to purchase or sell crypto assets. News articles and online forums may help you learn more about the reputation of a crypto trading platform or other service and the quality of its services. However, it is crucial to read third party information with a skeptical eye.
- Misleading online reviews – What you see online might be written by employees or other people paid by a service provider. Also, information could be outdated or inaccurate by the time you see it.
- Risk of fraud – Some fraudsters capitalize on market interest in crypto assets by creating new scams or rebranding existing scams (such as Ponzi schemes) with crypto language. They are looking for people who are seeking opportunities to get in “on the ground floor” with crypto assets. Learn to spot and avoid fraud.
- Lack of coverage by the Canadian Investor Protection Fund (CIPF) – The eligibility criteria for CIPF protection for securities held in an account with an investment dealer explicitly excludes crypto assets, which would include VRCAs.
Remember:
Like any investment, do not feel pressured to act quickly. Take your time to make a decision and take steps to protect yourself. If you are considering investing in crypto assets, always check the registration status of the crypto asset trading platform.
How can you protect your money?
If you are considering buying any type of crypto asset, make sure you understand the investment and the risks. These resources can help:
- Always use a registered crypto asset trading platform. View the list of crypto asset trading platforms registered in Ontario. However, just because a crypto asset, including a VRCA, is available for trading on a registered CTP does not mean that the VRCA is not risky.
- When in doubt, contact your provincial or territorial securities regulator, such as the Ontario Securities Commission.
- Learn the red flags of cryptofraud.
- Know the signs of investment fraud.
- Try the Crypto Quiz to test your crypto knowledge.
Summary
The term stablecoin is misleading since “stable” does not reflect how volatile these crypto assets can be. A more accurate term to use is value-referenced crypto asset (VRCA). A VRCA is designed and promoted to maintain a consistent value over time that is pegged to a reference asset. Keep in mind:
- VRCAs are subject to various risks and are not the same as fiat currency (e.g., Canadian dollars).
- The elevated risk may make VRCAs unsuitable as an investment for many investors.
- There is a risk that the mechanism that keeps the VRCA pegged to its reference asset (e.g. fiat currency) does not work and its value plummets.
- It may be difficult for you to determine who is responsible for any losses you have. You may not be able to get your money back.
- You may not have any rights to directly redeem your VRCA with the issuer and you may be required to sell it on a crypto asset trading platform. This means that you will only be able to sell it at the price that someone else is willing to pay for it, which may be significantly less than the value of the reference asset.
- Use a registered crypto trading platform if you decide — despite the risks — to trade crypto assets including VRCAs on a trading platform. However, VRCAs offered by registered CTPs are still risky and, unlike cash, VRCAs held with registered investment dealers do not qualify for CIPF coverage.
