Stablecoins are cryptocurrencies that are (most often) backed by a pool of real-world assets and aim to maintain a stable fiat value. This makes them an attractive option for crypto traders who want to exit the volatile cryptocurrency markets but without exchanging crypto for fiat.
In the recent years, stablecoins became the backbone of low-cap crypto trading. Some trading platforms that specialize in small altcoins do not even list fiat markets - LATOKEN and Phemex spot are fully on Tether.
The rest of the industry followed the demand: KuCoin has extremely limited fiat options and while Binance does support fiat, most of its trading is on their stablecoin markets.
Here we will take a look at the benefits of stablecoins that draw people to them, and risks of holding stablecoins instead of fiat.
What made stablecoins so popular?
High Lending Rates
The first benefit of holding stablecoins is that you can earn a high interest rate on them when compared to traditional fiat currencies.
This is because stablecoins are blockchain-based assets, which means they can be staked via DeFi protocols.
As a result, you get high interest rates on stablecoins everywhere - even in interest yielding schemes on centralized exchanges, who possibly use DeFi staking behind the scenes.
The only equivalent in the industry is lending fiat for margin trading - you can do that on exchanges like Bitfinex. But the yield is nothing like what you can get in stablecoins.
Additionally, the stablecoin lending rates from popular platforms are obviously much higher than interest rates in banks these days.
They can be integrated with smart contracts
The fact that stablecoins are blockchain-based assets is why they can be integrated with smart contracts. This allows you to use them in a wide variety of DeFi products.
Most of them are aiming at profit generation and since there is a lot of interest in decentralized trading, the potential to earn is there.
They can help you preserve your purchasing power…even in FUD
Another benefit of holding stablecoins is that they can help you preserve your purchasing power. This is not only because stablecoins are pegged to assets like the US dollar. It’s also because you can relatively easily switch between different stablecoins if you want to.
Tether is the most widely used stablecoin. In June 2022, Paolo Ardoino has been open on Twitter about attacks on the Tether stablecoin. Tether is an IOU stablecoin that is backed by government bonds and commercial debt. It withstands more withdrawal volume that most TradFi banks would, which shows that a solid backing is likely.
If the FUD comes and you do have doubts though, it’s easy to exit Tether for USDC. The USDT/USDC market exists on Phemex for instance, and you are not required to KYC to deposit, trade or withdraw stablecoins there.
They offer a higher degree of privacy
Another benefit of holding stablecoins is that they offer a higher degree of privacy. This is because most stablecoins are built on decentralized blockchains like Ethereum.
This means that your transactions are not subject to the same level of scrutiny as they would be if you were using a traditional fiat currency.
Additionally, you can now buy stablecoins on P2P platforms without KYC, which may allow you to remain anonymous when making transactions.
The centralized exchanges Phemex and Bitforex let you trade and withdraw USDT or USDC stablecoins without any KYC.
If privacy is important to you, stablecoins are a good option.
They can be pegged to other assets as well
Other than stablecoins pegged to fiat, there are also stablecoins are backed by commodities like gold or silver. These can also help to preserve your purchasing power and act as a proxy for investing in precious metals. A big part of precious metal trading does not trade the actual physical metal but a paper anyway.
Risks of stablecoins
The one thing that stablecoin holders rely on is the trust that the stablecoin will keep its peg.
It's important to note, however, that not all stablecoins are created equal. Some stablecoins may be more vulnerable to depegging than others.
Below are the main risks of using stablecoins.
Algorithmic stablecoin models can be opaque
As Deribit Insights explains, there are three types of stablecoins:
- Stables collateralized by USD and USD-generating assets, such as USDC and USDT
- Stablecoins over-collateralized by pools of crypto assets, such as DAI
- Algorithmic stablecoins, such as the infamous UST
Unlike the other two types of stablecoins, algorithmic stablecoins are not redeemable one-to-one for U.S. dollars and usually they are not backed by a collateral either. This means that algorithmic stablecoins can be reflexive, driven by market sentiment. That’s not exactly a good thing in a coin that is meant to be stable.
The idea of algorithmic stablecoins was to create a replica of fiat money in that people will believe that the stablecoin will maintain its peg, and will trade it back to parity in case of sell offs.
In reality, most stablecoin users do not have the time and skill to read whitepapers and judge if the logic of the stablecoin is sound at all. This can lead to a belief in a stablecoin that is fundamentally flawed, like it happened with UST.
A stablecoin’s collateral is not fully known
Stables backed by any sort of collateral might seem to shine in comparison here, but the issue with collateral is that it is never fully known.
Tether is backed by TradFi pool of which only a few vague data points is known: It had a lot of commercial debt, but in 2022 that was changed in favour of government bonds. Also there were private audits several times in the past.
In other words, source is trust me bro.
They are becoming more popular
As said in the intro in this post, stablecoins are widely used on most crypto exchanges. It is a benefit of stablecoins that they are becoming so popular, but it also lends itself to the fear that comes with every wave of FUD.
This is because more and more exchanges are relying pretty much only on stablecoins. Additionally, more and more businesses are beginning to accept them as a form of payment.
This trend is likely to continue as stablecoins become more widely adopted.
There are a number of benefits of holding stablecoins. They offer a degree of price stability, they are becoming more popular, and they are supported by most common crypto wallets.
In P2P trading strategies, stablecoins may be used to lower your trading fees and slightly increase your margins, if you are willing to take the risks.
Additionally, they can be integrated with smart contracts and offer a higher degree of privacy. If you are looking for a digital asset that is versatile and secure, stablecoins are a good option.
It's important to be aware of the risks associated with holding stablecoins, however. By knowing the potential risks, you can make a more informed decision about whether or not they are the right tool for you.