When it comes to crypto-assets, the headlines are usually bagged (pun intended) by the big two, Bitcoin and Ethereum, or the really small hundreds — more popularly known as shitcoins (usually coins with no max. supply cap, worth almost nothing, and that have no use cases). And Doge.
Crypto enthusiasts looking for value usually dive into the middle of this spectrum.
You hear stories about how a $1000 investment into Bitcoin in 2009, would’ve made you a crypto billionaire in 2021, or about how somebody made a million dollars out of a $100 investment into “SafeMoon” back in March ’21. You also hear about how a thousand people lost $200 each through the same investment into “SafeMoon”, but the difference was that they got in at the top. Volatility tends to swing the attention away from the actual impact that blockchain technology can have, and most people look at crypto as some sort of get-rich-quick scheme, or an outright Ponzi, neither of which it is.
What this hyper volatility also does is, give rise to the dread that, ultimately, whether you make money in the short term or not, enough exposure to the markets will leave you wishing you never got in. If your investment plan is to buy SafeMoon at the top, that very well may be the case. However, there is a safe way to grow wealth in the crypto space — without the hyper-volatility that may cause you to look towards fiat banking again — stablecoins. Now obviously for something to be ‘stable’ it must essentially be a good transfer of value — it should be worth a fixed amount of something.
Today, there are more than 150 currencies across the world that are recognized by the United Nations, from the US dollar to the Indian Rupee to the Japanese Yen, and more. Across global economies, these currencies are often used to buy goods and services. Despite inflation, fluctuating exchange rates, and other factors, the value of most of these currencies is subject to very little change on a day-to-day basis. This allows several economies and market participants to rely on the use of these government-issued currencies to operate. In other words, you can buy a can of Mountain Dew and pay $1.19 for it today knowing that it’s highly unlikely that it would drastically drop to 50 cents tomorrow.
Stablecoins — digital money — aim to mimic traditional, stable currencies. Simple enough concept, difficult execution.
Personally, I am on the fence about using them, since they ultimately route back to the fiat system — but there are some cases where its use is justified. None of this is financial advice, DYOR.
So how do you keep a crypto asset stable, when the rest of the market is going barbaric everyday? You back it with a stable ‘store of value’. Stablecoins are crypto assets that are 100% backed by either some stable currency, assets worth a fixed amount, a mix of stable currencies, and stable assets, or, non-collateralised stablecoins that are based on algorithms.
Fiat backed Stablecoins
Simply put, these are coins that have an equal amount of a fiat currency in the traditional financial system. For example, If you have $1000 in a bank account, you can create a stablecoin - whose supply is only 1000, with the promise that, if someone were to redeem that stablecoin, they would get $1 for 1 unit of that stablecoin. Essentially, as long as you maintain a fixed ratio, the peg will stay. A good example of a fiat backed stablecoin would be USD Coin (USDC) which is fully backed by the US dollar, in a 1:1 ratio.
Some assets are backed by part cash and part assets. Here, the equal peg ratio is harder to maintain, since the assets may fluctuate in price. Tether (USDT) is one such stablecoin, which is backed by both cash and other assets.
Overcollateralized Crypto-asset backed Stablecoins
Owing to the high volatility of the crypto-asset markets, creating a stablecoin backed by a crypto-asset requires overcollateralization. For example, if you have $100 worth of BTC, and store it in a smart contract — linking it to another smart contract that will create 50 stablecoins valued at $1 each. Now, my stablecoin value is 1 USD, while my collateral is worth 100. Liquidity exists. If the price of BTC falls by 50% — I can still afford to pay the redemption amount, if someone wanted to redeem the crypto-asset against which the stablecoin is pegged. Each stablecoin must maintain a minimum collateralization ratio and if the value of the collateral falls below said ratio, the position is automatically liquidated. The use of smart contracts allows for a decentralised entity to create a stablecoin.
These kinds of stablecoins are much much more difficult to execute. In theory, an algorithm keeps the price of the coin stable, by incentivising market participants to buy or sell in order to maintain price stability of the intended currency. It usually would work on a dual token system, with a secondary market.
Stablecoins are probably one of the most important elements in the blockchain, crypto-asset, and most importantly, in the decentralized finance ecosystem. They can be used to circumvent the volatility in the crypto-markets, for safe exits during intense price drops, or for moving crypto within the system, without exposing the holder to tax regulations by converting back to fiat. Stablecoins also offer the average investor a solid route into understanding the intricacies of the crypto-space, without exposing the user to high risk, and allows for greater yield opportunities, as compared to regular, more traditional investment vehicles.
None of this is financial advice, and before diving into any form of investment (be it in the traditional markets, or digital markets), always do your own research. Stay tuned to learn how you can put your stablecoins to use, and earn risk-free returns!