Stablecoin is a concept quite familiar to many investors in the cryptocurrency market. Stablecoins have a special role in the cryptocurrency market, being the favorite choice of investors in times of market volatility. Stablecoins promise to help connect crypto markets with traditional financial markets through its “Stable” feature.
So do you know about Stablecoins yet? Have you ever invested in Stablecoins? Do you have questions about whether investing in Stablecoins is safe or not? Follow the article below to learn more information about Stablecoin.
What are stablecoins?
Stablecoins are used to track the value of an asset or another currency and are normally traded on international exchanges in US dollars or euros. Stablecoins closely follow the price of fiat money or other assets. It is designed to minimize the impact of price fluctuations by being fixed to other assets such as fiat money, precious metals, or other cryptocurrencies.
With Blockchain and peer-to-peer value transfer characteristics, Stablecoin helps users avoid price fluctuations from other cryptocurrencies. Stablecoins help owners take profits and losses, transferring value at a stable price across peer-to-peer Blockchain networks.
Investors can use Stablecoins to participate in and escape the price fluctuations of cryptocurrencies instead of converting cryptocurrencies back into fiat money as before.
Features of Stablecoins
True to its name, Stablecoins are stable digital currencies that help keep the values of other assets stable.
By basing the asset’s value on another stable asset, Stablecoins will ensure its stability.
Stablecoins have properties such as:
- Decentralized
- High security
- Sponsored
- Strict control
What problems do stablecoins solve in Crypto?
Stablecoins were born to solve volatility, which is also the biggest problem in the Crypto market.
Investors or traders can transfer assets to Stablecoins instead of Fiat to avoid the volatility of cryptocurrencies. This is also a safe choice when the market is volatile.
Because of the volatility of 20-30% of the value in a short time of cryptocurrencies, it is difficult for many shops and companies to accept using crypto for payment. Therefore, the stability of Stablecoins can be considered by shops and companies as an alternative to traditional methods.
As can be seen, Stablecoins are important as a bridge between the cryptocurrency market and the traditional financial market in the transition from Fiat to cryptocurrency.
Stablecoins are important in the same way that a bridge is important. You may not care much about the bridge, but without it, the beautiful land beyond is much harder to get to
Erik Voorhees, CEO of Shapeshift
Why are stablecoins important to crypto?
An asset deficit is what investors don’t want to experience the most. The crypto market over the years has had great volatility; token prices can go up or down in just a week. This makes it difficult for investors to accept.
For example, you win and make a profit in a cryptocurrency, then you convert it into Fiat money, but the amount of Fiat money you have put in and withdrawn has no difference. So do you feel that although you have made a profit, you have lost it for no reason?
Accordingly, the stability of Stablecoins will help separate the high-risk/high-return characteristics of cryptos from the frequent volatility of crypto assets to become the most suitable storage and medium of exchange.
Advantages and Defects of Stablecoins
Advantages:
- Used for daily payments thanks to its price stability.
- Benefiting from Blockchain technology makes Stablecoins extremely versatile. You can send Stablecoins to any compatible crypto wallet.
- Stablecoins will help traders and investors hedge their portfolios.
Defects:
- Stable prices are not always maintained as the failure of projects to maintain the anchor depreciates the value of Stablecoins significantly.
- Lack of transparency: many stablecoins have not been fully and publicly audited but only have regular endorsements.
- More centralized than other cryptocurrencies: institutions holding collateral may be subject to external financial regulations to have significant control over the currency.
- Collateralized and unsecured stablecoins rely heavily on their community to function.
Stablecoin classification
There are currently 4 types of Stablecoins: Fiat-backed Stablecoin, Commodity-backed Stablecoin, Crypto-backed Stablecoin, and Algorithmic Stablecoin.
Fiat-backed Stablecoins
Cash-collateralized stablecoins are cryptocurrencies that are backed one-to-one by a government base currency (USD or EUR) or equivalent highly liquid assets.
Fiat-backed Stablecoin on the market is USDT, issued in 2013 by Tether Limited, and USDC, issued in 2018 by Circle. When you mint 1 USDC/USDT on-chain, 1 USD or equivalent asset will be stored.
Cash-collateralized stablecoins are typically managed by a central operator who monitors their circulation, and users can mint and redeem the tokens they hold. These reserves can be checked regularly to ensure that the number of tokens traded equals the reserves held by the company.
This type of Stablecoin requires users to trust custodians, not smart contracts on-chain, and it is also known as Custodial or Centralized Stablecoin.
Although there are many controversies surrounding the issue of centralization, currently, USDC and USDT are the two most used stablecoins in DeFi.
Commodity-backed Stablecoins
Commodity-backed Stablecoins are backed by the commodity they connect to. Each Stablecoin will be backed by one standard unit of the commodity.
Consequently, issuers of commodity-backed tokens should maintain audited physical reserves so that it is easy for users to redeem their tokens if desired.
The operation mechanism of Commodity-backed Stablecoin is similar to Fiat-backed Stablecoin but with a difference in peg value; the difference lies in its peg value. Fiat-backed Stablecoins with pegs are Fiat currencies, most typically the US dollar. Commodity-backed Stablecoins with pegs are precious metals, most typically gold and silver.
Most Commodity-backed Stablecoins take the value of gold as a peg. Tether Gold (XAUT) and PAX Gold (PAXG) are currently the 2 largest stablecoins in this segment.
Crypto-backed Stablecoins
Crypto-backed Stablecoin is a type of Stablecoin that directly uses crypto assets as collateral for its value.
These assets will be managed using open software to allow borrowers to lock up crypto assets and create new stablecoins as loans. Due to the volatility of the underlying cryptocurrency, these stablecoins are often over-collateralized; the required margin is usually a percentage higher than the stablecoin’s value.
Borrowers must return the stablecoin to the protocol and pay a fee to exchange their locked cryptocurrency. No one in the network can change the stablecoin supply. Instead, contracts are programmed to deal with changes in the market value of the locked asset.
For example, the typical stablecoin of this market is DAI. For every DAI minted in the market, $1.5 – 1.6 worth of assets will be collateralized in the Maker Vault. If the value of the collateral falls below the minimum threshold (typically 150%), the Vault will be liquidated, reducing the supply to bring the DAI price back to the peg price. In the low liquidity context of Crypto, Over-collateralized is a pretty good approach. It helps that many assets can always back DAI with a value greater than the total DAI Minted out. The limitation of this approach is that it is difficult to scale.
Algorithmic Stablecoins
These are digital assets that rely on smart contracts to regulate their stability.
Stablecoins have software that programmatically adjusts the supply of a cryptocurrency as its demand fluctuates. If demand is high, the stablecoin price will exceed the expected anchor and the software will increase the supply, whereas if the demand is low, the supply will decrease.
We will take Basis Cash as an example. The system’s stablecoin is BAC, issued without a reserve of collateral; its value will be preserved by algorithms that shrink and expand the supply when the price of BAC is above and below the peg. This model assumes that parties are actively involved in maintaining the price of BAC to earn relevant incentives.
Example of how Basis Cash works:
BAC is a Stablecoin pegged at 1$ and has a daily stabilization mechanism.
When BAC trades above $1:
- BAS Holder can Stake BAS ⇒ Earn Inflation (Earn BAC) according to the formula: (Your BAS/Circulating Supply BAS) * Total Supply BAC * (TWAP BAC Price – 1).
- BAS Holder earns BAC Free, so according to the model theory, they will sell to the market to make a profit ⇒ Selling pressure pushes BAC price down to 1$.
- For example, when a user is holding 10 BAC and the price of each BAC is $0.8, then the user can use 10 BAC to buy 15,625 BAB.
- Supposedly, 3 days after the BAC price increase to 1$, the user can exchange 15.625 BAB = 15.625 BAC and sell BAC on DEX and earn almost 50% profit from his 10 BAC.
According to this pattern, buying pressure pushes the price of BAC to $1.
Not only Basic Cash, there are many other algorithmic stablecoins on the market with many novel operating models. In general, there are 3 main price-holding models:
Rebase: Keep the token price by adjusting the number of tokens in circulation. If the token price rises above $1, the number of tokens in the holder’s wallet will automatically increase and vice versa. Typical tokens: AMPL, BASE.
Seignorage: Use multiple tokens to keep the price of the original Stablecoin. Based on their price difference, traders will arbitrage to bring the Stablecoin price to the peg. Typical tokens: UST, BAS, FEI.
Fractional: Combination of Fiat-backed Stablecoin and Seigniorage Stablecoin. Typical token: FXS.
Stablecoin Investing: Will Stablecoins Become Trending?
Established in 2013, Stablecoins have been booming, with more than 36 consecutive Stablecoin projects launching in 2018, accounting for more than 54% of the total Stablecoins.
Looking at the chart, it can be seen that Stablecoin started with 7 projects in 2014, with the first project being USDT. With that pretty good starting point, during this period, there were many Stablecoin projects born on the cryptocurrency market and attracted much attention from the community.
Giants such as J.P. Morgan Bank’s JPM and Facebook’s Libra have also participated in Stablecoins to help Stablecoins grow more and more.
In addition to ensuring the safety of investors’ assets, Stablecoins also help us generate passive income safely.
Yield Farming
Yield Farming is using a pair of tokens to provide liquidity, thereby receiving rewards from the platform. This token pair can be Stablecoin –Stablecoin or Stablecoin – Altcoin. The second option offers a higher return but means higher risk because Impermanent Loss can occur.
Yield Farming is closely linked with AMM; the Liquidity Providers in Yield Farming provide liquidity to the Liquidity pool; the pools will allow users to borrow, lend, or exchange between tokens.
A few platforms that allow stablecoin farming:
- Curve Finance: 3 – 35% APY.
- Convex Finance: 2 – 28% APY.
- Saber Finance: 3 – 20% APY.
- Ellipsis Finance: 4 – 70% APY.
Staking
Staking is holding and locking a certain amount of coins to receive rewards. This amount of coins will be locked for some time in the wallet or nodes of a Blockchain project. Staking is more secure than Yield Farming because staking only requires the supply of 1 token instead of 2. Of course, the interest rate will also be lower.
A few platforms that allow Stablecoin staking:
- Binance: 3 – 13% APY.
- Yearn Finance: 2 – 22% APY.
- Stargate Finance: 4-6% APY.
Lending
Lending is the lending of Stablecoins; users use their Stablecoins to lend to others at a certain interest rate. After a while, they will get both principal and interest back as agreed. Providing Stablecoins via Lending is the same as Staking.
A few platforms that allow lending Stablecoins:
- Aave: 2-7% APY.
- Compound: 1-2% APY.
Where to buy Stablecoins?
Currently, quite a few investors are interested in stablecoin investment. This is a fairly safe investment vehicle and helps investors make a profit.
To be able to buy Stablecoins, investors can refer to the two exchanges below:
- Via the CEX exchange: All CEXs support purchasing and selling Stablecoins in many ways, such as using crypto assets or with money in the bank card.
- Via DEX: There are DEXs created with the main purpose of supporting the exchange of Stablecoins with low slippage, such as Curve Finance, Ellipsis, or Mobius.
- Direct Mint: Instead of buying Stablecoins, you can also mint them directly using collateral. Projects that support this work can be mentioned as MakerDAO (DAI), Abracadabra Money (MIM),…
Conclude
The article has summarized information about Stablecoins, including its concept, mechanism, characteristics,… It can be seen that Stablecoin has stable value and is quite safe for investors in the period of market volatility. Investors or traders often hold stablecoins to take advantage of new market opportunities quickly.
However, investing in Stablecoins is not 100% safe; many potential risks can occur. Therefore, you need to make wise choices in choosing Stablecoins for investment and reputable exchanges to minimize possible risks.
