Learn: What the h*** is a stablecoin?

• Hi guys ????, during a two-hour car ride, I chose to look into stablecoins, as I saw enormous interest rates. So below is the information I gathered from a range of different sites and put together for myself, and now for you guys. Sorry for potential layout mistakes, as I’ve put this together on my phone ????. Enjoy!

Basically, stablecoins suggest a new alternative for reducing price volatility in the crypto landscape. The volatility makes cryptocurrency somewhat unreliable as a suitable currency for exchanging goods and services. So, the best stablecoins which have emerged in the crypto space have solved this problem. By nature, stablecoins are highly fixed in terms of value when compared to general cryptocurrency alternatives.

According to a report by CB Insights, the overall value of stablecoin assets has crossed well over $20 billion in late 2020. Stablecoins have gained traction as they attempt to offer the best of both worlds—the instant processing and security or privacy of payments of cryptocurrencies, and the volatility-free stable valuations of fiat currencies.

They promise lower volatility, which makes them useful for converting between fiat and other cryptocurrencies. Some of the most prominent examples are: USDT, TUSD, DAI, PAX, GUSD.

What makes fiat currency free from extreme volatility?

When a fiat currency’s valuations may move drastically, the controlling authorities jump in and manage the demand and supply of currency to maintain price stability. The bulk of cryptocurrencies lacks both these key features - they don’t have a reserve backing their valuations and they don’t have a central authority to control prices when required. Stablecoins attempt to bridge this gap between fiat currencies and cryptocurrencies.

The different types of stablecoins

Stablecoins can be fixed to almost anything in theory, there are Stablecoins fixed to multiple fiat coins and even to precious items like gold or silver. Four main categories exists:

Backed by a commodity: Stablecoins that are pegged against commodities generally have the backing of hard assets for stability. The hard assets could include real estate or gold.

Backed by a crypto asset: Crypto-collateralized stablecoins are backed by other cryptocurrencies. Since the reserve cryptocurrency may also be prone to high volatility, such stablecoins are “over-collateralized”—that is, a larger number of cryptocurrency tokens is maintained as reserve for issuing a lower number of stablecoins. More frequent audits and monitoring add to price stability. However, because the crypto values themselves are not stable, these Stablecoins need to use a set of protocols to ensure that the price of the stablecoin issued remains at $1.

Backed by fiat currency: Fiat-backed cryptocurrencies as the most commonly accessible stablecoins. Such types of stablecoin have the backing of fiat currencies such as the US Dollar, Euro, or Chinese Yuan, which are kept as collateral (a fiat currency reserve is maintained). Such reserves are maintained by independent custodians and are regularly audited for adherence to the necessary compliance. Production and liquidation of the coin is carried out by the issuer of the coin.

Backed by an algorithm: Non-collateralized stablecoins don’t use any reserve but include a working mechanism, like that of a central bank, to retain a stable price. For instance, the dollar-pegged basecoin uses a consensus mechanism to increase or decrease the supply of tokens on need basis.

But… but… but…

Placing you money in a stable coin is not without its risks as many stablecoins lack consumer protections and provide patchy, frequently unaudited accounts of the reserves meant to back their coins. Tether, the $60bn stablecoin, was fined $18.5m by the New York attorney-general over allegations it lied about its reserves.

When should you care about stablecoins?

If you cannot keep a close eye on market conditions or changes, or if you are simply not familiar with all these, it may be wise to keep your digital assets in Stablecoins. Also, during bearish market times, you can favourably keep your digital assets in stablecoins.

Why are they interesting?

With stablecoins you can minimise volatility, trade or save assets, transfer money cheaply, send money internationally, and lastly the one I’m going to focus on here, you can earn interests.

Currently, exchanges like crypto.com offer up to 14% (!!!!) p.a. Interest on certain stablecoins. To me, that sounds ludicrous, as my bank currently offers me next to no interest (some even make you pay for keeping your OWN money with them). So what is going on in the crypto space?

How can you get a hold of these high interest rates?

By using a third-party crypto loan platform - you will be lending your stablecoins out. In return, you will be paid a rate of interest that in many cases is significantly higher than what you can get through a traditional savings account.

Your chosen crypto loan platform will charge the end-user a higher rate than what you receive in interest (called the spread) – this is how the provider is able to pay you.

However, there seem to be two main risks: (1) As mentioned earlier, a stablecoin provider needs to hold a reserve of an asset, so at some point it comes down to trust, and their ability to keep the reserve intact. (2) You need to consider the safety of the platform itself. After all, it is not the stablecoin provider that is paying you interest. On the contrary, this is paid by a third-party that collects digital currencies from depositors and then lends the funds out via a loan agreement. Furthermore, you are NOT insured.

Lastly, you should be aware that most places (if not all?) you have to “lock up” your stablecoin holding for a certain period of time to accrue the “abnormal” interest rates.

TL;DR - You can place your savings in high interest stablecoins, but it is, in theory, at the risk of losing your entire investment.