There is little chance that a conversation about cryptocurrencies has no mention of the term — volatility. The price actions too have backed this narrative of volatility being the prominent quality of cryptocurrencies.
However, in the same vein, the phrase ‘hedge against inflation’ is used as a prime reason as to why one needs to park their money in Bitcoin or other cryptos than in fiat.
Without delving deeper into any of the narratives, let us explore a new opportunity that acts as an anti-thesis for both volatility and inflation.
For this, we need to understand the phenomenon of stablecoins.
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Stablecoins: The Antidote for Volatility
Let’s talk numbers first — the total market cap of stablecoins currently stands at nearly $165 billion, growing by over 500% since January 2021. Now, what are these stablecoins? Simply put, stablecoins are a class of cryptocurrencies whose market value is fixed or pegged to a certain fiat currency.
For example, a stablecoin like Tether (USDT) is pegged to the US dollar which means 1 USDT (Tether) is always valued at USD 1. The value of 1 Tether or any other stablecoin will remain consistent with the fiat currency they are pegged to at all times.
Stablecoins achieve this stability by a unique facet of collateralization which is the fact that they are always backed by reserves. These reserves can be in the form of fiat currencies, other cryptos, or commodities. An emerging type of stablecoins is the algorithmic stablecoins where the coins derive their stability from algorithms that essentially control the supply of the coins.
Now, let’s delve into a relevant and real-world event — inflation.
Inflation: the Death-knell for Purchasing Power
Recently, the US recorded its highest inflation rate in the last 4 decades which currently stands at around 7%. Similarly, Turkey has been fighting an inflation crisis since 2018. The Turkish inflation rate has hit nearly 36%. Can this get any worse? Argentina says ‘Yes’ as its economy is estimated to suffer from an inflation rate of 54.8%.
All of these numbers result in one common thing i.e. decrease in the purchasing power of the currencies. Keeping aside the political impact on inflation, there is one direct cause of inflation — the entry of money into circulation. Governments across the globe are notoriously known for printing more money into circulation at any given instance of economic distress.
One of the prime reasons behind the 7% inflation rate of the US is the unprecedented printing of money worth $3 Trillion in 2020. This meant 18% of the total supply of US Dollars was created in 2020 alone. The M2 money supply chart above illustrates the exponential increase after March 2020.
Similarly, when the money supply is increased at an alarming rate, citizens have more money to essentially purchase the same amount of goods. This causes the price of goods to rise at an unsustainable rate causing hyperinflation. An ideal example of this is when Zimbabwe printed its way into an economic disaster in 2008, the effects of which can be felt to date.
What we need to derive out of these examples is the fact that fiat currencies are designed to lose value over time. This is where investments come into play with which people aim for capital appreciation of their money in the form of securities, real estate and other assets. However, this locks their money for a period of time which means a lack of liquidity.
Now, an interesting situation arises where the general population wants to secure their money’s value while still maintaining liquidity. This brings us to the involvement of stablecoins as a hedge for inflation.
Enter The Stablecoin Way of Negating Inflation
Stablecoins can be the answer for those wanting to retain their money’s value while still having the ability to transact on a daily basis. Since their prices are stable, they can be used as a credible medium of exchange. Stablecoins can also replace the conventional mode of cross-border payments that is plagued with intermediaries, transaction fees, etc.
Anyone with access to the internet can transact with stablecoins and be involved in the global economy. This also acts as a platform for true globalization to take place. According to the World Bank, more than 2 billion adults remain unbanked. The ease of access to stablecoins is a bright opportunity for financial inclusion to happen at a global level and scale.
Citizens of Turkey or Argentina could have maintained their value of money by investing in stablecoins during inflationary times. Not only do they retain their purchasing power, but they are also one step closer to accessing decentralized financial (DeFi) services. With DeFi growing its wings across lending, insurance, gaming and more, stablecoins and DeFi can essentially replace certain services in the fiat and banking sector.
Though this is a slight exaggeration, there is a weightage to the argument as the crypto and DeFi industry is maturing and turning mainstream. Also, with governments talking and acting on crypto-based regulations, stablecoins can be a safe bet for all.
To further substantiate my claim, here are two recent developments that may suggest stablecoins would play an increasingly vital role in the global economy:
Four FDIC-insured banks in the US are joining hands to mint a stablecoin called USDF in order to facilitate peer-to-peer and B2B money transfers.
Hong Kong Monetary Authority (HKMA) has issued a paper on ‘Crypto Assets and Stablecoins’ in which a question up for discussion reads “Stablecoins could be subject to run and become potential substitutes of bank deposits.”
Launched in 2014, USDT is a stablecoin issued by a company called Tether Limited, which is controlled by the owners of Bitfinex, and is pegged to the US Dollar in a 1:1 ratio. Each USDT is purportedly said to be backed by an equal amount of dollar reserve. Not only is USDT the largest stablecoin by market cap, but is also the third largest cryptocurrency by market cap only behind Bitcoin and Ethereum.
APY for USDT ranges from 7% on Binance Savings to 9.5% on BlockFi.
USD Coin (USDC)
USDC is pegged to the US Dollar in a 1:1 ratio, USDC is issued and managed by a consortium called Centre. Notable crypto firms like Circle, Coinbase and Bitmain are members of this consortium.
According to Circle, USDC is fully backed by cash and cash equivalents like short-term US Treasury bonds. Major blockchains like Ethereum, Solana and Avalanche support USDC natively.
To uphold transparency, Circle publishes a monthly public attestation by a top accounting firm of how USDC is fully reserved and is 100% redeemable for US Dollars. Read the latest report here.
APY for USDC ranges from around 10% on Celsuis to 3% on Aave.
Binance USD (BUSD)
BUSD is another fiat-backed stablecoin pegged to the US Dollar. Partnering with Paxos, Binance created BUSD in 2019. Uniquely, BUSD is approved by the regulatory body — New York State Department of Financial Services (NYDFS).
Binance has also aggressively pushed real-world uses like its partnership with BitPay, a global crypto payment service provider. Merchants on BitPay like Microsoft and Amazon are now equipped to receive BUSD payments.
Though a ERC-20 token, BUSD is also supported by BEP-2 making it the most feasible stablecoin on the Binance Smart Chain. Similar to USDC, monthly audits of BUSD are released by Paxos and can be viewed here.
APY for BUSD ranges from around 7% on Binance Savings to 8.88% on Celsius.
Decentralized stablecoin UST is the fourth largest stablecoin by market cap. Contrary to the previous ones, UST is not managed by a company or consortium. In collaboration with Bittrex Global, Terra launched UST in September 2020.
Also, UST is an algorithm-based stablecoin, hence, there is no need for a fiat reserve to complement the issuance of UST. Rather, Terra’s native token. LUNA coupled with algorithm-based smart contracts maintains the price stability of UST. It is the predominant currency for dApps in the Terra Ecosystem.
In the absence of collateral requirements, UST stands apart in the stablecoin market and is not affected by scalability concerns.
APY for UST ranges around 19.3% on Anchor Protocol.
A unique algorithmic stablecoin managed by a DAO — decentralized autonomous organization, DAI is pegged to the US Dollar. The issuance of DAI is governed by the MakerDAO where decisions are community-driven. The decisions are then self-executed by Ethereum-based smart contracts.
The minting of DAI is collateralized by a mix of cryptocurrencies like ETH, BAT, USDC, COMP and others. Users also use the DSR (DAI Savings Rate) systems to lock their DAIs and earn interest on the locked DAI.
APY for DAI ranges around 3.8% on dYdX to 8% on Nexo.
Should You Invest in Stablecoins?
The above two actions coupled with the growing inflation crises across the globe provide more backing for stablecoins to be used as a hedge against inflation. This not only protects the general population from having to risk their all on volatile cryptocurrencies but also provides them easy access to a global financial market.
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