Stablecoins: The Ultimate 2022 Guide | Dollar Bureau

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Stablecoins: The Ultimate Guide

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Cryptocurrencies are very hot right now!

Whether you’re planning for your retirement or want to board the investment train and put extra money on the side, trading with crypto is a good way to boost revenue.

Although everyone wants to invest in crypto, the high level of volatility makes the ordeal risky. Luckily, we have stablecoins to level this problem.

This category of cryptocurrencies is more stable because of the assets backing it up.

But, how safe are stablecoins? What are the best stablecoins in today’s market? How do these work?

Here is a detailed guide to help you learn the basics of stablecoins and how they work.

What are Stablecoins?

Crypto is an excellent way to add more to your savings accounts, but just like everything else – there is a small catch.

Namely, the problem with crypto is that they are too volatile, i.e. they can change drastically from one minute to the next.

This is the main reason why many still don’t have second thoughts about trusting the cryptosystem.

As of 2009 – when Bitcoin first came to market – and up until now, there have been many attempts to legalise cryptocurrencies and create a safety net around this digital cash.

One of these tries resulted in what we now know as stablecoins.

Stablecoins are cryptocurrencies that are tied to some asset that has real value. Usually, they are pegged to some currency, gold, or even other precious metals.

Some stablecoins are tied to crypto as well – but we’ll get to that later.

The reason why people opt for stablecoins is their stability. Because they are tied to some type of goods or other resources with a “tangible” value, stablecoins don’t fluctuate in value as much as other cryptocurrencies.

A Historic View

Historically speaking, Bitcoin emerged first to the market. But, many didn’t want to invest their retirement funds in something that could blow up the next day.

This is where the idea of stablecoins came to mind.

In 2014, the first stablecoins showed up on the market. Many think that the first one was Tether, but in reality, there were 2 before this giant took over the market – BitUSD and NuBits.

BitUSD was pegged to other cryptocurrencies, which is why many still didn’t trust it.

On the other hand, NuBits used the seigniorage system, which was still in the making.

Luckily, TetherUSD entered the market, and it practically saved the day. Understandably, TetherUSD has faced some issues with the law as well.

However, the fact that it remains one of the best stablecoins speaks for itself.

How Does Stablecoins Work?

Stablecoins are the easiest to understand from all types of cryptocurrencies. The way they work is simple. Typically, they are all tied to some asset that has real value.

That might be the Singapore dollar, US dollar, Euro, or others.

Sometimes, stablecoins will be pegged to the price of gold, too. Regardless of the asset backing it up is, companies offering stablecoins always has backed up reserves from these real-world assets.

This is what makes the stablecoin less volatile. Stablecoins usually have a ratio of 1:1, which adds more to their stability.

To put it simply – for every S$1 the company has, 1 stablecoin is tied to it.

You can check how much the quantity of a stablecoin is by simply researching how big their tied assets are.

Stablecoins are an easy medium of exchange that acts as a bridge between fiat currency and crypto. Also, stablecoins belong in the decentralised finance (DeFi) industry.

It also helps to know that stablecoins are legal in Singapore. A testament to this is the fact that there are a few stablecoins like XSGD that are pegged to the Singapore dollar.

To make it simpler, here are the key points of how stablecoins work:

  • They are decentralised. What this means is that they are not tied to any centralised system or agency and are fully autonomous. They work on smart contracts on the blockchain network, which gives traceable, transparent, and irreversible automatic transactions.
  • They allow faster transactions and give financial data privacy, even with international transactions.
  • They give the chance to bypass some financial fees.
  • As digital cash, stablecoins are protected from fiat market crashes. In case the fiat drops, users can exchange them for another currency in a matter of seconds.

 

Some countries like South Korea have allowed stablecoins to be used as other currencies in commerce. This just proves that stablecoins could become the next fully accepted digital currency.

However, even if stablecoins are less volatile and more secure than other cryptos, they are still cryptocurrencies. Those waters are still new to the world and may bear some undiscovered risks.

Types of Stablecoins

Before you start looking for the best stablecoins, you first need to make sure that you understand the types of stablecoins that exist on the market.

There are 2 general stablecoin types:

  • Asset-collateralised
  • Non-collateralised

 

Asset-Collateralized Stablecoins

These stablecoins are the most common on the market. They are backed by resources that have real value. These would include all currency-based stablecoins and those based on precious metals.

The idea behind these stablecoins is to use the blockchain system and create digital money. Why? Because it has been proven by now that digital currency is faster, has a good level of security, and with stablecoins, it is just that – stable.

There are 3 types of stablecoins that fall under asset-collateralised:

  • Fiat-backed stablecoins
  • Commodity-backed stablecoins
  • Crypto-backed stablecoins

 

Fiat-Backed Stablecoins

If you’ve ever read anything about stablecoins, fiat-based are probably the ones you’ve found first. This type of stablecoin is mostly used to describe to beginners what stablecoins are.

Fiat-backed stablecoins are cryptocurrencies that are pegged to some type of real currency. Usually, they are tied to the US dollar or Euro, but there are many other stablecoins that connect to different currencies.

The easiest way to look at fiat-based stablecoins is like an “I owe you” (IOU). You buy stablecoins in some currency by providing a certain amount of it.

The company accepts them and issues you an adequate number of stablecoins. You can look at these as cryptographic promises that you will get real money in the end

So, that company now “owes” you until you decide to withdraw your funds. And the stablecoins are proof of that.

The second you want to take that action, the company gives you back what it owed so far, i.e. the amount you’ve initially deposited, in the same currency, with additional benefits – if such exist.

Every fiat-backed stablecoin company gives out this crypto, only if it previously has a valid amount of that fiat in its reserves.

The ratio between stablecoin and fiat plays a significant role to determine how much they need.

Usually, this ratio is 1:1. So, for each stablecoin, there is an equivalent fiat. As I said, you can check this amount of the company in their circulating supply.

As good as fiat coins are, there are some disadvantages you need to have in mind.

First, they are tied to traditional payment methods, so they can be slower and more expensive than other stablecoin types.

These are also centralised since they are tied to an asset regulated by a specific country.

However, this can also be seen as a pro because regulations are what most people are comfortable with when it comes to cryptocurrencies.

Commodity-Backed Stablecoins

Also known as precious metals backed stablecoins, commodity-backed stablecoins work the same way as fiat-backed stablecoins.

The only difference here is that these are tied to some type of commodity i.e. precious metals like gold, silver, or platinum.

If you look up this type of stablecoin, you will see that most commodity-backed stablecoins are pegged to gold.

This is understandable considering that gold is the only asset globally that has preserved its value over centuries.

How they usually tie them is by the same ratio – 1:1. Simply said, they peg one gram of gold to one stablecoin. So, so long as the company behind them has a good reserve of the precious metal in question, they can give out as many stablecoins as they’d like.

A solid example of a gold-based stablecoin is Tether Gold (XAUT). The current circulating supply of it is around 105,549 XAUT.

Crypto-Backed Stablecoins

Unlike other stablecoins on our list, this stablecoin type is tied to a cryptocurrency.

The intriguing part is that it doesn’t have to be tied to only one currency, nor should it, because of the high volatility cryptos have.

A more acceptable option would be to tie these to several cryptos and distribute the risk in turn.

But, even with this, the stablecoin will remain sensitive to fluctuations and drop-downs.

This is where over-collateralisation comes into the picture.

Overcollateralisation means that the company behind the crypto-backed stablecoin puts more crypto into their vaults, but gives fewer stablecoins in turn.

For example, if the ratio is 1:2, then, for every 1 stablecoin, there will be 2 crypto coins added to the vault.

When it comes to cash – for every S$100 worth of stablecoin, there will be S$200 worth of cryptos to support it.

Although these are simple, decentralised, and pretty transparent, crypto-backed stablecoins have some disadvantages too.

The most important one is volatility. In other words – that is the possibility of losing everything that you’ve invested because of the highs and lows of the crypto behind it.

Also, there is always the possibility of instant liquidity if the value of the assets falls under some predetermined limit.

DAI is a stablecoin that works on this method. This stablecoin is soft-pegged to the US dollar but is still backed by many cryptos.

The most notable one is Ethereum, making DAI a trustworthy crypto-backed stablecoin.

Non-Collateralised Stablecoins

Unlike asset-collateralised stablecoins, this type is a bit more complicated.

Non-collateralised stablecoins are a hybrid of 2 opposite views.

One view suggested that cryptocurrency shouldn’t be an asset-collateralised stablecoin because it has no tangible value.

At the same time, the opposing view suggested that crypto still has some pre-arranged value, even though we do not see it.

As a middle ground for these, non-collateralised stablecoins came into the world. These are stablecoins whose value comes from the users’ expectations of maintaining a specific value.

There is only one main non-collateralised stablecoin – the seigniorage or algorithmic stablecoin.

Seigniorage (Algorithmic) Stablecoins

This is the last type of stablecoins and the hardest one to understand.

Seigniorage stablecoins are modelled after the central banks’ management over their country’s currency.

They use an algorithm to expand and contract the crypto to keep it around its initial value.

Simply said, this algorithm buys and sells the stablecoin automatically when the price goes over or under the predetermined limit.

Seigniorage stablecoins first made the market in 2014 in a paper by Robert Sams.

Yet, despite the growing interest in them, they still remain the least used stablecoins.

As an example of how they work, imagine a stablecoin has the value of S$1.

When this rate goes higher even to S$1.1, or less to S$0.9, the algorithm activates and immediately adds more to the supply to bring the coin down.

Sometimes it also pulls from the supply to bring the price up.

What Fees are Involved in Stablecoins?

When talking about fees, there are 2 main types to go over.

The first type includes exchange fees, which are also the ones that influence the fees surrounding stablecoins.

Each company has several fees that it poses for you to be able to trade, withdraw, and deposit.

The fees will vary between providers and can change. So, make sure that you regularly check the company that provides the stablecoin and your crypto exchange.

The next type is network (gas) fees. Stablecoins are digital assets, and as such, they are stored on networks worldwide.

There is no third-parties running point, so to trade with them, you need to pay the gas fees.

You’re practically directing your digital money to the stablecoin miners with these fees. That way, they give you access to the blockchain network.

Advantages of Stablecoins

Stablecoins are an excellent and safer way to back up your reserves.

Here are all advantages that this type of cryptocurrency offers.

  • Less volatile – Because stablecoins are tied to assets that are less fluctuant in price, they can keep their initial price without bringing drastic changes as other cryptos do.
  • Borderless – Like every other cryptocurrency, stablecoins are a form of digital cash, so you can quickly move them globally, without regard to international borders.
  • Faster – As digital cash, stablecoins are way faster for making transactions than other traditional methods. Plus, with stablecoins, you don’t have to worry about waiting on a third party to verify the transfer. This also means –
    no third-party fees.
  • Transparent – Because stablecoins use a blockchain network, they are recorded on a public ledger. This is the opposite of fiat currency because anyone can monitor stablecoins.

 

Stablecoin Risks

As good as they sound, stablecoins don’t come with only advantages.

They might be less volatile, but they are still new and are using new technology that can come with many risks.

Here are some disadvantages tied to this type of cryptocurrency:

  • Centralised – This part is a little tricky. As I mentioned, stablecoins are part of DeFi, but the fact that a centralised entity still issues them remains. You can see how this goes against the primary idea of decentralised finance.
    For example, if you are holding on to USDT and the Tether suddenly drops, all your assets will go away with it.
  • Must be audited – Stablecoins must be audited, and for that to happen, third parties are involved. This again takes away the idea behind DeFi.
  • Absence of transparency with the assets – Some stablecoin companies are not open where they keep the assets backing up your stablecoin. Because of that, you can’t quite be secure in knowing where your assets are going. This can become a bigger issue, if, say, the company potentially closes due to regulations issues in the country, causing you to lose all investments.
  • Less income – Unlike other types of cryptocurrencies, stablecoins are pegged to the asset’s value. So, if the asset doesn’t increase its worth, neither will the stablecoin.

 

How to Make Money with Stablecoins

Yes, stablecoins are more secure because they are tied to the value of an existing asset.

But, this also makes it less profitable than simply owning a cryptocurrency.

So, you might wonder why you would own stablecoins in the first place if there is not a valuable amount of income that you can use for your future.

Don’t worry – there are several popular approaches to help boost your passive income.

Let’s look at each individually.

Peer-to-peer Lending

Peer-to-peer (P2P) lending is one way to earn more on your stablecoins. With this method, you deposit a number of your stablecoins to a company, which then connects you to another person who wants to borrow that same amount, i.e., matched lending and borrowing.

The company is a simple middle man that connects both sides. In return, the lender earns a predefined interest and the same amount they have initially given.

Lending Pools

Lending pools work on the same method as P2P lending but with some differences.

In lending pools, you give as much as you want, but unlike P2P all of your assets here fall in a pool that is made up of thousands of this type of loan.

In here, the borrower can take more than what you’ve initially put, but you can also withdraw your stablecoin without the need to wait for the loan to mature.

Lending pools are also called Peer-To-Pool lending, where parties don’t interact with each other like in the Peer-To-Peer lending system but directly to a communal pool.

This pool is managed by smart contracts on EVM blockchains, i.e. blockchains that work on the Ethereum platform, where an algorithm determines the interest rates for both sides.

In other words, there are no middle parties here, so the costs are lesser. The lender doesn’t have to negotiate any terms such as maturity of the loan, interest or so on.

This type also brings an upside for the borrower – they don’t have to go to a different P2P contract to get a larger amount than what the lender in P2P offers.

Look at it through an example.

Let’s say you want to borrow S$500 worth of stablecoins, but the lender in your peer-to-peer contract only has S$400 worth of stablecoins.

Instead of going to a different peer-to-peer contract, you can reach into a lending pool and take out the total amount from there.

In lending pools, the risks are higher but so are the interest rates.

The main risk revolves around what would happen if the whole pool drains suddenly, i.e. someone takes away the entire amount in it.

However, considering how popular this method has become, this is not likely to happen.

Lending on Your Own

This approach takes effect when you decide to lend your money on your own. Here, you practically work on the P2P system except not having a company to mediate.

There are open-sourced platforms or protocols to borrow stablecoins and then lend them elsewhere.

You can use different liquidity pools, but it’s always best to find the one with the best annual payment yield (APY).

A company that does this is Compound.

Staking

Last but not least is staking. This is a method where you lock your stablecoins in a vault for some time and then earn some type of reward as a result of it.

These rewards can be extra mining, network voting rights, or others.

This process is common with stablecoins that use the proof-of-stake algorithm.

And the best part is that, when the stablecoins are released, you’ll get interest from them as well.

Where to Buy Stablecoins

To buy stablecoins, you will first have to find a good crypto exchange. Note that some providers might not be available in Singapore, so always check this before you decide to invest.

The market has many options for you to invest in right now. Here are some of the best crypto exchanges where you can buy stablecoins:

 

Conclusion

Stablecoins are the safest option for all types of cryptocurrencies. They are less volatile, and although not entirely risk-free, they are more financially reliable and offer more extensive legal safety.

All in all, stablecoins are a great way for any moderate investor or beginner to profit from cryptos.

You can boost your investment portfolio and have a stronger safety net for your retirement and overall future.

All in all, stablecoins make an ideal approach to early and ongoing investing, promising you a financially ripe and stable future ahead.

Disclaimer: Each article written obtained its information from reliable sources and should be purely used for informational purposes only. The information provided by Dollar Bureau and its affiliated parties is not meant to be construed as financial advice. Dollar Bureau shall not be held liable for any inaccuracies, mistakes, omissions, and losses incurred should you act upon any information listed on this website. We recommend readers to seek financial planning advice from qualified financial advisors. 

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