Stablecoins serve as a link between traditional financial markets and cryptocurrency markets, giving investors and advisors a new opportunity.
Stablecoins, a phrase that refers to cryptocurrencies that are tethered to fiat currencies like the US dollar, first appeared in 2014. That year, Tether (USDT), formerly known as realcoin, was introduced as the first stablecoin. It was a one-of-a-kind product at the time, aimed to bring the dollar’s (and other government-backed currencies’) stability to the cryptocurrency environment.
Fiat-backed coins, crypto-backed coins, and algorithmic coins are the three main types of stablecoins available today. Stablecoins backed by fiat are cryptocurrencies that are 1:1 collateralized with a fiat currency. Stablecoins that are backed by a specific cryptocurrency are known as crypto-backed stablecoins, whereas algorithmic stablecoins are stablecoins that use a complicated algorithm or algorithms to match the price of the cryptocurrency to the price of a fiat currency.
What are some of the applications for stablecoins?
Stablecoins rose to prominence on cryptocurrency exchanges that didn’t allow fiat trading pairings. Because most cryptocurrencies are highly volatile, many traders and investors sought a trading vehicle that provides stability while avoiding this volatility. Stablecoins may be easily exchanged between exchanges because they are cryptocurrencies. This enhances liquidity in the cryptocurrency market and allows traders to profit from cross-exchange arbitrage opportunities. Tether, the gemini dollar (GUSD), USD coin (USDC), and other prominent stablecoins are just a few examples. Tether and USD coin are two stablecoins in the top ten cryptocurrencies by market capitalization.
Lending and borrowing are another common use case for stablecoins, notably in the decentralized finance (DeFi) industry. Traders and investors would frequently borrow against their crypto holdings or let their coins to be lent out to other borrowers in exchange for the chance to earn a profit.
In the crypto ecosystem, stablecoins offer a lot of the plumbing. Because stablecoins are in high demand, borrowing and lending rates are frequently higher than average. Stablecoins can be used to generate interest by placing them into various lending pools. In this scenario, smart contracts — the code that powers crypto lending pools – act as traditional banks, with savers supplying liquidity to borrowers. Most liquidity pools, unlike traditional finance (TradFi), provide instant liquidity.DeFi is the term for this notion, and it’s becoming increasingly popular.
While stablecoins are intended to be “stable,” it’s crucial to be aware of the hazards. Each type of stablecoin carries its own set of hazards, which advisors and investors must be aware of.
Fiat-backed: These are coins that are controlled by a single entity. This necessitates the issuer’s possession of fiat currency. Investors should demand verification of reserves and audits on a regular basis. USDT, GUSD, and USDC are some examples.
Stablecoins supported by cryptocurrency are far more volatile than those backed by fiat currency. Proof of reserves, as well as continual monitoring of the crypto used to back the stablecoin, are necessary. DAI is a good example.
Algorithmic-backed: Investors should look at the code that was utilized to develop the algorithmic function that creates stability. AMPL and terraUST are two examples (UST).
Stablecoins provide opportunities
Advisors and investors have a unique opportunity with stablecoins. They cannot and should not be used as a substitute for cash, despite the fact that they are supposed to be stable and non-volatile. And, while it would be ideal to transfer bank deposits to a stablecoin position in order to earn a competitive rate of interest (particularly during periods of inflation), keep in mind that these products are still new and unproven.
Stablecoins, on the other hand, provide an appealing return, allow for borrowing and lending, provide huge liquidity in the crypto ecosystem, and provide an uncorrelated (to other cryptocurrencies) asset that may be traded or included in a diversified crypto portfolio.
Bringing the two worlds together (TradFi and DeFi)
Stablecoins, in my opinion, have built the bridge that will connect traditional financial markets with the wild world of crypto markets. I’m more optimistic about DeFi’s future than I was about Bitcoin in 2012. Advisors must be educated on the hazards and opportunities that this new DeFi world will bring as it develops. The next few years of the TradFi/DeFi ecosystem merging may present chances unlike any we’ve seen before.