May
25, 2021
6 min read
Opinions expressed by Entrepreneur contributors are their own.
When investing in crypto, stablecoins are a necessary piece of any successful strategy. These are cryptocurrencies pegged to the dollar’s value. However, creating a legally compliant, decentralized and fair stablecoin is more complex than one might think.
Where do millennials invest?
With the Nasdaq, Dow Jones and S&P 500 all hitting all-time highs this month, you wouldn’t believe that we’re living through a pandemic and recession. However, this has everything to do with it. To get out of the Covid-19 economic crisis, governments will have to print money to save struggling sectors. In the face of a falling dollar, investing is more than a nice bonus — it is necessary to preserve wealth. With the Federal Reserve Chairman himself admitting he expects a rise in inflation, a clear message has been sent to everyone — invest your money in anything but a savings account. This message has been heard loud and clear.
Currently, one of the most exciting areas to invest is cryptocurrency. Interest has grown exponentially, leading even the world’s second-richest man, Elon Musk, to invest in Bitcoin. More than a technology, crypto (more precisely, DeFi) aims to challenge the current financial system and recreate it in a fairer, more transparent way.
As prices of real estate rise and commodities such as gold have a hard time keeping up, millennials turn their sights and savings to the fast-growing digital asset class. It’s fun, it’s easy, and it moves quickly. This has led the crypto market to cross the $1 trillion mark at the beginning of 2020. Perhaps even more impressively, the market doubled that a few weeks ago by crossing $2 trillion. The more people believe in it, the faster cryptocurrencies grow.
This has created an increasing demand for a particular type of cryptocurrency, though, one that isn’t likely to grow in value but rather provide utility and stability to the crypto market: stablecoins.
Related: 4 Ways DeFi Can Generate Passive Income
What are stablecoins?
In the simplest terms, stablecoins are cryptocurrencies tied to the value of a currency backed by government regulation and a central bank, such as the U.S. dollar. Very often, this is the currency used by stablecoin providers to guarantee the value of their cryptocurrency. But why would anyone want a cryptocurrency tied to the price of the dollar? Doesn’t that defeat the whole point of investing in cryptocurrencies?
It’s not so simple. While no crypto investor will only hold stablecoins in their portfolio, these have become a vital part of any investment strategy for many reasons. First, they’re an excellent way to transfer a set amount to another person. For example, in the case of a business contract, it’s much easier to agree on a value in dollars than in a volatile cryptocurrency. If you had negotiated a 1BTC monthly salary in March 2020 when Bitcoin traded around $4,000, the contract would undoubtedly pose problems to your employer now that Bitcoin hovers around $50,000.
Second, while the dollar has been on a downward trend in 2021, this decline is slow. By all accounts and purposes, the dollar is a stable currency. This makes stablecoins pegged to their value a good option when it comes to taking profits on successful trades. Often, traders will realize their profits on cryptocurrency trades in stablecoin or predict downturns by converting their crypto assets to stablecoins on crypto exchanges.
The very first stablecoin, Tether, shows why stablecoins can often be problematic. To legally justify their ability to provide stablecoins, Tether declared they would back every single USDT 1:1 with real dollars that could be unlocked if crypto users decided to return their stablecoins. However, this turned out to be false and legal issues followed for Bitfinex, Tether’s parent company.
Related: Tesla CEO Elon Musk Says Bitcoin Purchase is ‘Less Dumb’ Than Holding Cash
A fair and transparent stablecoin
Stablecoins collateralized by real dollars will always be centralized, and this centralization, as was the case for Tether, can lead to abuses. While these are still the most widely used stablecoins, questions about the transparency and credibility of their parent company will always create issues and slow down growth for the crypto market.
On the other hand, stablecoins collateralized by crypto assets such as DAI from MakerDAO allow crypto users to collateralize their digital assets, such as Bitcoin or Ethereum minting DAI, a stablecoin. To regain access to these assets, users have to return the DAI. The problem lies in the fact that if the price of Bitcoin or Ethereum falls and the assets become under-collateralized, the user’s funds can be liquidated and sold to the highest bidder to recuperate its funds.
This also allows investors to increase their leverage. If you were to collateralize Ethereum and borrow DAI, you could use it to buy more Ethereum and increase your exposure. But beware, amplified profits could also lead to amplified losses, and liquidations are a genuine threat in crypto.
The last stablecoin model is the algorithmic one in which stablecoins are not collateralized. These work with a rebase mechanism in which, every 24 hours, the price of the token returns to $1. If there is a lot of demand, new stablecoins are minted and distributed to holders, while if there isn’t enough, the coin returns to $1 and a portion is taken out of circulation.
The stablecoin market is ripe for disruption, and one protocol has an interesting take on a fairer stablecoin. Standard Protocol has developed a model which profits from the strengths of both crypto-collateralized stablecoins and the rebase mechanism to solve the outstanding issues inherent to prior stablecoin models.
First, Standard Protocol is decentralized and its governance is left to its community. This transparency protects it from legal issues and increases the credibility of the protocol. In this protocol, digital assets are collateralized and, if needed, sold fairly through an open automated market maker system that allows anyone to take art in liquidation auctions.
This collateralization of the stablecoin with tangible digital assets will allow Standard’s stablecoin MTR to be more stable than algorithmic stablecoins as the value of each coin will be backed by the user’s assets. These assets could even be natural commodities such as a tokenized representation of gold.
By embracing the elegant but unstable model of algorithmic currencies and backing it with real, valuable assets, Standard Protocol is developing one of the most exciting stablecoin projects so far. This may become the de facto protocol for stablecoin usage in crypto.
Related: Mark Cuban Says Explosive Growth in DeFi Is ‘Like the Early Days of the Internet’