Whether you are a trader, investor or casual saver, stablecoins are for you. Traders need liquidity for exchanging crypto assets. Relying on traditional banking may be too slow to move funds from different exchanges to trade crypto. This is why stablecoins exist. It offered a transparent and efficient method of moving money to buy and sell cryptocurrency around the world.
In October 2021, Yahoo Finance put out an article claiming Ethereum had settled $6 Trillion in crypto assets and stablecoins. It was also reported that in January 2021, 74% of all stablecoins were issued on Ethereum. This shows how popular stablecoins are. This is also why the yield on stablecoins are much higher than traditional savings accounts.
The liquidity of stablecoins is great. Indeed, it allows traders to easily trade cryptocurrencies on different exchanges. They do not have to wait 5 business days for withdrawals. It also allows traders to take on leverage by taking loans from a broker to buy more crypto.
Before regulators criticized crypto exchanges about the extraordinarily high leverage traders were using, it was common that most exchanges offered up to 100x leverage. This meant for every $100 a trader had in their account, they could borrow up to $9,900 to buy more crypto. If more traders take on leverage, the demand for stablecoins would push borrowing rates higher.
Investors may use stablecoins to get liquidity without selling their crypto. For example, $100 in Bitcoin could be used as collateral to borrow $50. This liquidity could then be used to pay bills, rent etc. This way investors would not have to sell their Bitcoin and in doing so will not incur any tax liabilities.
Risks on cryptocurrency
However, investing and trading crypto do not come without its risks. Both are risky endeavours that are not for the faint hearted. As Cointelegraph puts it, 95% of crypto traders lose money with 80% of them quitting within their first 2 years. Cryptocurrencies are very volatile and can often fall 30% or more within a day. During market turmoil over this past weekend, Monday, and leading into Tuesday, over $300 B left the crypto market sending many tokens crashing 30-40%. Specifically LUNA fell 53% in one day.
With over $1 B in liquidations reported by multiple exchanges, the traders and investors were the losers here. However, what about the casual saver? If you do not like the volatility of crypto, stablecoins are still a great option for you. The yields generated in DeFi are much higher than traditional bank savings accounts. Yields often hover from 5% to as high as 20% APY. In market conditions like yesterday where the broad market sold off over 15%, yields actually increased due to lack of supply of stablecoins.
The yield in DeFi is a simple supply/demand dynamic. As more traders feel the need to use leverage, the demand of stablecoin increases which also correlates with an increase in APY. As more investors borrow against their collateral, the demand to borrow those stablecoins increase and so do the APY for the lenders.
Even though the opposite is true, we have not seen yields less than 1.5% which is still 15 times more than the traditional bank offering. Whether you are saving for a house, a car, or your child’s college fund, using DeFi yields to compound your money can be a solution.
Risks with DeFi
Before putting your life savings on the line, keep in mind that there are still risks with DeFi. Some risks are systemic, such as bridges being exploited which can make bridged tokens unredeemable for the real token. Others are isolated incidents such as a smart contract exploits for a particular protocol. Over the last 2 years, there has been over $3 B in DeFi hacks. Some of the more recent ones was the Axie Infinity hack that caused $600m in crypto to be stolen. This is an alarming amount but in actuality, $3 B is less than 3% of the entire DeFi market.
Although the risks of DeFi are higher than FDIC insured banks, if DeFi protocols are carefully selected the reward outweighs the risks in most cases. Since the start of the year, the S&P 500 index is down over 15%. Mortgage rates are climbing, gas prices haven’t been this high in over a decade, and inflation is still very hot.
When all other assets like gold, stocks, and crypto have been losing value, stablecoins offer a great hedge because you can beat inflation with DeFi all while preserving capital in stablecoins assets.
Some might even argue that stablecoins are safer than FDIC insured banks. This is because banks usually operate on a reserve basis of 10%. In other words, for every $100 deposited in a checking account, $90 is digitally created and lent out to customers to earn interest for the bank.
Similar to what happened in the 2008 financial crisis, the low 10% reserve requirement and other factors caused many banks to go under because they lent out too much money and did not account for the default risk. In contrast, most stablecoins are over 70% collateralized.
Meaning for every 1 stablecoin that is created, it can always be redeemed for at least $0.70 USD at any time. This is because the Circle Attestation claims that 60% of all USDC is backed by cash, about 12% is backed by US treasuries, and the rest is backed by short term corporate debt, CDs, and other investment vehicles. This makes it more collateralized than dollars in a checking account.