One of the most common words used when describing cryptocurrencies is volatility — and for good reason; it is the violent price fluctuations of the major cryptocurrencies that capture the attention of the public. Decidedly less attention is paid to stablecoins, which may not offer as much in the way of exciting headlines, but have been central to DeFi’s rapid development.
What’s more, the higher profile and greater use of stablecoins mean they are becoming a focus for governments. Just recently:
- USDT (Tether) continues to reign supreme, with a market capitalization larger than all other stablecoins combined.
- Circle (the company behind USD Coin) merged with Concord Acquisition Corp — a special purpose acquisition vehicle (Spac) — to be listed on the New York stock exchange with a valuation of US$4.5 billion.
- Visa announced that transactions could be settled with USD Coin.
While chair of Concord Acquisition Corp, Bob Diamond, claims stablecoins are “…an increasingly critical part of the global financial system”, other countries such as China, see a risk, due to monopolization and the “disorderly expansion of capital.” Other countries such as New Zealand and the US are also looking at future payment systems, with the role that privately issued stablecoins or government-controlled central bank digital currencies (CBDCs) may play, and the benefits and risks of each model.
In this blog post, we’ll answer common questions, such as:
- What is a stablecoin?
- Are stablecoins good for investment?
- What features make a decentralized stablecoin?
- What makes a good stablecoin wallet?
What are stablecoins?
Put very simply, a stablecoin is a cryptocurrency that remains consistent in value to the asset it is pegged to. While the most popular stablecoins are pegged to US dollars, a stablecoin can be tied to precious metals, real estate, or a mix of different crypto assets.
What keeps stablecoins stable?
The underlying asset – Stablecoins are a hedge against volatility when sending cryptocurrencies across borders, or purchasing currencies on a centralized cryptocurrency exchange or DeFi platform. For the most part there are no problems, as stablecoins are pegged to assets such as the US dollar, which is itself stable. If the stablecoin were pegged to the New Iraqi Dinar, for example, it wouldn’t be worthy of its name.
The issuer – Most stablecoin issuers are at pains to show that they are reputable. Stablecoins such as USD Coin (USDC) and Digix Gold (DGX) are regularly audited and are backed 1:1 with their underlying asset, while USD-backed Gemini stablecoin (GUSD) and Paxos Standard (PAX) were the first two cryptocurrencies to be approved and regulated by the New York State Department of Financial Services. Despite temporary drops in consumer confidence, which have been known to affect the stablecoin price, Tether (USDT) has solidified its reputation by consistently being the most used and operating on more than 7 blockchains.
Are stablecoins a good investment?
This blog post does not give financial advice, and in any case, it is hard to give a blanket investment recommendation that covers everyone’s needs. As with most investments, whether purchasing stablecoins can bring rewards comes down to an individual’s circumstances, targets, and expectations when investing. We will examine some of the benefits and risks of stablecoins below to give you an idea of what you are likely to deal with if you do decide to invest.
Benefits of stablecoins
Stablecoins are a good example of what was initially intended when cryptocurrencies were formulated; to make a simple, stable, and scalable store of value that could be used for transactions, ensuring security, speed of settlement, and transparency. For the most part, the top stablecoins do a pretty good job, bringing the following benefits:
Cutting global transaction costs – When pointing out the advantages of stablecoins, stablecoin evangelists often say that you can pay your rent and loans with them easily. While this is true, in most countries, domestic bank transfers can be made with little or no fees, and have become a lot faster in the last few years.
International transfers are where things get messy. Foreign workers sending money back to their families have historically had to deal with middlemen such as banks or other financial services companies taking a cut. Sending stablecoins involves lower fees and almost instant settlement as a direct P2P transfer. The same applies to benefits apply to Bitcoin and other altcoins, but with their price volatility, stablecoins represent the safer option.
There is also a distinct benefit for a company paying workers based in different countries. A smart contract can be set up to pay out salaries at a certain time of the month using stablecoins, without having to go through the hassle of running through multiple financial service providers.
Safe haven currency – As we’ve seen lately, the price of Bitcoin and altcoins has taken quite a hit. In order to temporarily stem losses, active traders may shift their holding temporarily into stablecoins as a safe haven until the market recovers.
Stablecoin interest – Tied to the point above, you can stake a stablecoin on both centralized and decentralized exchanges to help provide the necessary funds to run an application or expand its ecosystem through development. Simply by holding a stablecoin on a particular DeFi protocol, you can gain much better interest than putting your fiat funds into a deposit account at the local bank.
Stablecoin advantage on exchanges – With more of the big centralized and decentralized exchanges offering direct fiat conversions and fiat holdings on their respective platforms, you may be wondering why stablecoins are still so widely used. While it is easier than ever to convert fiat to crypto in one step, with trading pairs being added all the time, stablecoins can move between exchanges much more quickly and often at a better rate.
There is also an incentive for exchanges to provide advantageous conditions when using their native or preferred stablecoins, for the reasons that you are using their technology, and helping provide both stability and liquidity to the exchange itself. Using the USDC stablecoin or Binance Dollar (BUSD) typically has much lower fees (or none) when it comes to trading pairs than if you were to be exchanging any fiat currency.
Battling high inflation – There is a reason why cryptocurrency use is so high in African, Asian, Eastern European, and South American countries; they provide some security when local currencies are subject to fluctuations and/or high inflation. Going by a compilation of reports from Statista’s Global Consumer Survey, a huge 32% of respondents in Nigeria said they hold cryptocurrency, with common double-digit inflation of the Nigerian naira being a key reason.
Risks of stablecoins
We have seen many benefits, but of course, there are some risks that need to be considered.
Potential loss of the 1:1 peg – There is no guarantee that a stablecoin will stay pegged to the asset that it is linked to. While many US dollar-linked stablecoins seem to perform quite well, gold pegged stablecoins are riskier.
As discussed above, there are also issues around issuer credibility that can cause a price drop, and whether a stablecoin is 1:1 backed or algorithm-based, “black swan” events (a sudden drop in user demand) can cause a coin to lose its peg. This was emphasized by Fei Protocol, which dropped to under 70 cents when demand fell.
Risk of smart contracts in general – When transferring funds on a blockchain using smart contracts, the coin price is one factor that can cause concern, the other is the technology of the network itself. While centralized exchanges have a greater degree of safety, decentralized exchanges and other DeFi products are still grappling with smart contract failures and hacks, which we detail in our blogpost: TOP 10 recent DeFi hacks that have affected the whole industry.
Centralization of stablecoins and lack of transparency – While one of the key foundations of cryptocurrencies is transparency and decentralization, there is a danger that with the growth of stablecoins, power can be concentrated in the hands of a centralized company. The Tether stablecoin (USDT), which has a market cap (at the time of writing) of over US$62 billion, has come under fire for a lack of robust audits and suspected (but not proven) Bitcoin price manipulation. This is a legitimate concern and one that has not been effectively addressed by governments or those in the blockchain community.
Regulation – Cryptocurrency regulation is constantly evolving, with more countries bringing in tax laws related to digital assets. In countries like Australia, where every exchange is a taxable event, some of the benefits of quick exchange between fiat, stablecoins, and other cryptocurrencies can be wiped out.
Stablecoins as an investment
As we see above, stablecoins are already playing a large role in the global financial system and are the main fuel for DeFi expansion. As part of a thriving blockchain ecosystem, transacting with these cryptocurrencies or earning interest through yield farming (where a coin is locked up to provide liquidity to a protocol) can bring rewards. However, stablecoins are far from infallible, and they should be invested in with a degree of caution.
What is the best decentralized stablecoin?
As described above, currencies like USDC and USDT are backed with a physical reserve of US dollars, meaning there are off-chain actions controlled by a centralized agency. In contrast, the cryptocurrency Dai is soft-pegged to the USD, but is done through smart contracts and crypto-collateralization. Other notable examples of decentralized stablecoins include EOSDT and Frax.
The Dai stablecoin is often held up as an example of a successful decentralized currency; however, a recent article from CoinDesk argues that there are still further innovations on the way to true decentralization, such as purely algorithmic stablecoins with no collateral required, and a pivot away from the dollar standard to encompass something even more stable, such as a set of assets that track the Consumer Price Index (CPI), a better reflection of purchasing power than simply following a currency.
Best stablecoin wallet features
Like other cryptocurrencies, stablecoins stored in wallets can help protect them from hacks, and offer a range of features for trading and sending. One wallet won’t necessarily be best for all users, as people come with different currencies and levels of expertise, as well as their preferred platform or operating system. Saying this, there are certain features that everyone can agree are desirable to have in a stablecoin wallet, which are:
- A wide range of supported coins
- An easy-to-use interface
- The ability to undertake a range of operations
- Integration with hardware wallets
- Monitoring features
- Low fees
It’s best to do extensive research on the best wallet for you, but if you can’t find one that fits all your requirements, you can always hire a specialty blockchain software development company to create a custom wallet to your exact specifications.
Stablecoins offer a simple proposition; a currency on a blockchain that stays at more or less the same price. Behind this idea is much complexity, as we have seen from this post. With stablecoin investment having grown by more than 300% in 2020 and continuing its rise into 2021, this currency is positioning itself as an increasingly important part of the financial conversation, which is why it is gaining attention from national governments and big tech, such as Facebook with its Diem stablecoin. In an upcoming post, we will dive further into the different types of stablecoins and present a stablecoin list, taking a closer look at some of the most popular coins. For any other blockchain, cryptocurrency, or DeFi related questions, look to INC4, a team of experienced specialists that have been working exclusively with blockchain since 2014! From DeFi wallet development to mining pools and project consulting, INC4 can assist. Visit our homepage for more information or book a call with a member of our knowledgeable team.