Stablecoins are digital currencies that are linked to a “stable” reserve asset, such as the US dollar or gold. In comparison to unpegged cryptocurrencies like Bitcoin, stablecoins are designed to lessen volatility.
What are stablecoins?
Stablecoins are digital currencies that are linked to a “stable” reserve asset, such as the US dollar or gold. In comparison to unpegged cryptocurrencies like Bitcoin, stablecoins are designed to lessen volatility. Because their prices are fixed to a reserve asset like the US dollar or gold, stablecoins serve as a link between cryptocurrency and regular fiat currency. When compared to Bitcoin, this significantly minimizes volatility, resulting in a kind of digital money that is better suited to everything from everyday commerce to cross-exchange transactions. The idea of combining traditional asset stability and digital asset flexibility has proven to be a huge hit. Stablecoins like USD Coin (USDC) have attracted billions of dollars in worth as they’ve become one of the most popular ways to store and transfer value in the crypto ecosystem.
Why do they exist?
The most well-known application of innovative blockchain technology is cryptocurrencies. Stablecoins can be backed by actual assets, unlike fiat currencies like the USD or EUR, which are supported by market faith in the issuing governments. Stablecoins provide a sense of stability in a volatile market by keeping their value fixed.
Stablecoins provide the same benefits to cryptocurrency investors, traders, and exchanges as fiat money does to non-crypto currency financial market participants: stability. When volatility rises, non-crypto currency investors shift their portfolios to cash, Treasury bonds, or money market funds, whereas cryptocurrency investors shift to stablecoins.
Stablecoins are preferred by bitcoin market participants over traditional ‘risk-off’ assets for a variety of reasons. For one thing, being in the cryptocurrency market allows them to shift between trades more quickly without having to wait days for their funds to be converted to fiat currency. It’s also true that not all cryptocurrency exchanges allow fiat currency trading, leaving stablecoin as the only option.
Market participation in terms of volume and market capitalization has progressively increased since stablecoins have provided a way to find safety in the cryptocurrency market. More people are deciding to participate in the cryptocurrency market as their confidence in it grows.
More movement, or volume, has happened as stablecoins instill more confidence in the market by providing participants with a safe area.’ This increased volume has resulted in a corresponding increase in liquidity, making the bitcoin market both faster and more efficient. Increased efficiency also means more precise asset pricing, which means fairer asset prices and narrower bid-ask spreads.
The advantages of stablecoins are numerous, and they have provided a significant boost to the entire cryptocurrency market. The market has gained trust, grown, and become more efficient as a result of providing a ‘risk-off’ mechanism. However, not all stablecoins are created equal, so understanding how they work may aid you in deciding which one to utilise when the time comes.
Drawbacks of stabelcoin
There are a few disadvantages to stablecoins to consider. Stablecoins have different pain points than other cryptocurrencies due to the way they are normally set up.
Counterparty risk is another vulnerability if the reserves are held by a bank or another third party. It ultimately comes down to this: does the entity have the collateral it claims to have? Tether, for example, has been repeatedly questioned about whether it maintains a real 1-1 backing between USDT tokens and US dollars. In the worst-case situation, a stablecoin’s reserves may not be adequate to redeem all of its units, causing the coin’s credibility to be shattered.
Cryptocurrencies were designed to take the place of middlemen who are generally trusted with a user’s money. Intermediaries, by their very nature, have power over that money; for example, they can usually prevent a transaction from taking place. Some stablecoins reintroduce the option to halt transactions.
If the USD currency is used in an illegal manner, it has a back door that may be utilized to stop payments. In July 2020, Circle, one of the companies behind USDC, stated that it has frozen $100,000 of the stablecoin at the request of law enforcement.
How you can make money from them?
Stablecoins can be used to earn interest – In this instance, your stablecoins are managed by a third company. Simply put, you deposit the necessary number of stablecoins, which are subsequently used by the company to provide secured loans to third parties. You get your money back plus the interest that has been collected over time, which may be as high as 12% per year, at the conclusion of the agreed period. This allows you to benefit from passive income while also spreading the risk of lending. This works well with both fiat and commodity-backed stablecoins.
Lending stablecoins on your own – This option is similar to the previous one, except that you handle crypto lending on your own and are thus responsible for all risks. You can borrow and lend bitcoin on a short-term basis on a platform like Compound, shifting your assets among liquidity pools in a constant search for the one that currently offers the highest yearly percentage yield (APY). To get the most out of this strategy, you must thoroughly investigate all financing options available, assess risks, and occasionally manage paperwork, among other things. Knowing all of the ins and outs of the industry is a must here; otherwise, dangers skyrocket, and they are enhanced by default compared to the strategy above.
Stablecoin staking – The network will reward you if you lock your stablecoins to ensure the proper operation of the entire network on which they circulate. This is known as staking, and it is very frequent in systems that use the Proof-of-Stake algorithm. A user deposits funds in a specific wallet, node, or platform that they do not have access to. In return, users receive a stake in the system in the form of network voting rights, mining incentives, or other benefits, depending on the situation. This strategy, which is similar to making a bank deposit in more than one way, pays a little but guaranteed interest. Because the economic stimulation may be modest, this strategy is ideal for people interested in the technological growth of the coin in question.
Overall, dealing with stablecoins is one of the most effective ways for a somewhat risk-averse trader to earn from cryptocurrencies. They provide a diverse range of collateralization alternatives to suit various investing preferences and, in general, are a good approach to mitigate the risks associated with crypto. While they are not completely risk-free, they provide greater financial and legal security than any other type of crypto asset.