Stablecoin Investment: A Beginner's Guide To Getting Started

Stablecoins are a type of cryptocurrency that is designed to maintain a fixed value over time. They are less volatile than other cryptocurrencies, making them an attractive option for investors who are wary of the extreme price fluctuations seen in Bitcoin and Ethereum. Stablecoins are backed by reserve assets such as the U.S. dollar, gold, or other cryptocurrencies, which helps to keep their prices stable. They are also used in crypto trading as they provide a functional currency within a crypto brokerage and can be used with smart contracts. While stablecoins may not offer the same explosive gains as other cryptocurrencies, they can be a good option for investors seeking a more stable investment.

Understand the different types of stablecoins

Stablecoins are cryptocurrencies whose value is pegged to that of another currency, commodity, or financial instrument. They are designed to maintain a stable value and provide an alternative to the high volatility of other cryptocurrencies, making them more suitable for everyday transactions.

There are four main types of stablecoins, categorised by the assets used to stabilise their value:

Fiat-Collateralized Stablecoins

Fiat-collateralized stablecoins, also known as fiat-backed stablecoins, are the most popular type of stablecoin. They maintain a reserve of a fiat currency (or currencies), such as the US dollar, as collateral, assuring the stablecoin's value. Tether (USDT) and TrueUSD (TUSD) are popular examples, with Tether being the third-largest cryptocurrency by market capitalisation as of late June 2024. Fiat-backed stablecoins are commonly used for trading, remittances, and lending and borrowing activities within the decentralised finance sector.

Commodity-Backed Stablecoins

Commodity-backed stablecoins, also known as asset-backed stablecoins, are pegged to the market value of commodities such as gold, silver, or oil. These stablecoins generally hold the commodity using third-party custodians or by investing in instruments that hold them. Tether Gold (XAUt) is one of the most popular commodity-backed tokens, backed by gold reserves held by an unnamed custodian in Switzerland.

Crypto-Collateralized Stablecoins

Crypto-collateralized stablecoins, also known as crypto-backed stablecoins, are backed by other cryptocurrencies. Due to the volatile nature of cryptocurrencies, these stablecoins are generally over-collateralised, meaning the value of the cryptocurrency held in reserves exceeds the value of the stablecoins issued. MakerDAO's Dai (DAI) stablecoin is pegged to the US dollar but is backed by Ethereum (ETH) and other cryptocurrencies worth about 155% of the DAI stablecoin in circulation.

Algorithmic Stablecoins

Algorithmic stablecoins may or may not hold reserve assets. They maintain their price stability by controlling their supply through an algorithm. The stability of algorithmic stablecoins is heavily dependent on market demand. If demand decreases below a certain threshold, the entire system can falter. TerraUSD (UST) is an example of an algorithmic stablecoin that experienced a significant de-pegging event when its price fell below $1, leading to a massive sell-off.

Learn how stablecoins differ from other cryptocurrencies

Stablecoins are a type of cryptocurrency that differs from other cryptocurrencies in that they are designed to maintain a fixed value or stable price by being pegged to another asset, such as a fiat currency or gold. This is in contrast to popular cryptocurrencies like Bitcoin and Ethereum, which are highly volatile and can fluctuate drastically in value. Stablecoins are often backed by the specific assets they are pegged to, such as fiat-backed stablecoins like Tether (USDT) and USD Coin (USDC), which are pegged to the US dollar. Crypto-backed stablecoins like DAI are backed by other cryptocurrencies, while commodity-backed stablecoins like Tether Gold and Paxos Gold are backed by precious metals or other commodities.

Another difference between stablecoins and other cryptocurrencies is that stablecoins are typically non-interest-bearing, meaning they do not provide interest returns to the holder. Additionally, stablecoins are used for payments and are more likely to retain their value compared to highly volatile cryptocurrencies. Stablecoins can also be used in various blockchain-based financial services and to pay for goods and services.

The stability of stablecoins makes them less risky than other cryptocurrencies. They are less subject to volatility and fluctuations in value, making them more suitable for everyday transactions. Stablecoins also provide a fast and cheap way to transfer money or make payments on a global scale, as they are available 24/7.

However, stablecoins still present some risks, including security risks, counterparty risk, reserve risk, and lack of confidence. It is important for investors to carefully read the fine print and reserve reports of stablecoin issuers to understand the underlying assets backing the stablecoin and the potential risks involved.

Research the risks of investing in stablecoins

Stablecoins are a type of cryptocurrency designed to maintain a stable value relative to a specified unit of account or store of value, such as a national currency (often the US dollar) or a commodity (e.g. gold). While stablecoins aim to offer traders a safe haven, there are several risks associated with investing in them.

Counterparty Risk

Stablecoins rely on a third party to print money and keep the cryptocurrency stable. This means that the dollars could be fractionally reserved instead of fully backed. In this case, a bank run could cause the price of the coin to drop dramatically.

Centralisation Risk

Centralisation risks mean the same monetary issues fiat currencies face when a central authority has the power to print money without oversight. This can potentially lead to hyperinflation. Accounts can be embezzled, blocked, or accessed by unauthorised third parties.

Algorithm Manipulations

Most decentralised stablecoins live within smart contracts in protocols like Ethereum or Stellar. There's a risk the algorithm that keeps the currency stable fails. Algorithms could even be manipulated by a third party. Updates to the network can also impact previous smart contracts – a huge hassle for decentralised projects.

Redemption Risk

Redemption in full and on demand at par is not guaranteed due to the possibility of a 'run' (rapid withdrawal of funds with redemption compromised by illiquidity of assets). Algorithmic stablecoins not backed by financial assets are highly susceptible to runs.

Operational Risks

Stablecoins and other crypto-assets are susceptible to operational risks, including fraud and cyber risks. These risks arise from the opacity and complexity of the crypto ecosystem, the widespread use of third-party service providers, and a lack of recourse for lost or stolen crypto-assets.

Financial Stability Risks

Stablecoins currently pose minimal risks to financial stability because of the small size of the market relative to other asset classes and the limited use of stablecoins outside the crypto ecosystem. However, continued growth and new use cases could introduce risks, including by strengthening the links between the crypto ecosystem and the traditional financial system.

Energy and Climate-Related Impacts

Some stablecoin technologies rely on proof-of-work consensus mechanisms to validate transactions, which are highly energy-intensive and have the potential to contribute to climate change. More widespread adoption of stablecoins for applications such as payments may depend on issuers migrating to less energy-intensive technologies.

Explore ways to make money with stablecoins

Stablecoins are a type of cryptocurrency that is designed to maintain a fixed value over time. They are less volatile than other cryptocurrencies, making them a more stable form of currency. Stablecoins are backed by reserve assets, such as the US dollar or gold, which helps to keep their prices stable.

• Earn interest: Holding your money in stablecoins on a cryptocurrency exchange is a low-risk way to make money by earning interest on stablecoin balances. Many cryptocurrency exchanges offer daily interest on holdings, with no minimum balances and few fees.
• Lending: Lending your stablecoins to borrowers is another way to earn money. Crypto lending is an alternative investment form where investors lend fiat money or cryptocurrencies to borrowers in exchange for interest payments. The rate of return can range from 5% to 12% annual percentage yield.
• Staking: Staking involves participating in maintaining the flow of the blockchain network on a certain asset. By putting your own coins at stake, you have the chance to earn rewards. The more coins you pledge, the more you can potentially earn.
• Passive income: Stablecoins can offer generous passive income options on cryptocurrencies. For example, staking cryptocurrencies can result in large monthly profits, although this strategy does involve an element of risk.

Compare stablecoins with other investment options

Stablecoins are a type of cryptocurrency designed to maintain a fixed value over time. They are often pegged to a specific real currency, like the US dollar, and their value is meant to remain stable relative to the currency they are pegged to. This makes stablecoins less volatile than other cryptocurrencies like Bitcoin, which fluctuate greatly as speculators push their prices up and down.

Stablecoins are backed by multiple sources, including fiat currency, other cryptocurrencies, precious metals, and algorithmic functions. The type of backing source can affect the risk level of a stablecoin. For example, a fiat-backed stablecoin may be more stable because it is linked to a centralized financial system with a regulating authority. In contrast, a stablecoin that isn't linked to a centralized financial system, like a bitcoin-backed stablecoin, may change drastically and quickly due to the lack of a regulating body.

Compared to other investment options, stablecoins offer a less risky entry point into the crypto world. They provide a hedge against inflation for fiat currencies and offer the benefits of digital currency, such as lower transaction fees, faster transfers, and accessibility. The largest stablecoins, with substantial market capitalizations, have demonstrated the potential for widespread adoption, suggesting a level of stability and reliability attractive to investors.

However, stablecoins have limited appreciation potential compared to other crypto assets due to their design for stability. They are also subject to regulatory uncertainty and the potential for mismanagement of reserves, particularly with centralized stablecoins. Additionally, the risks associated with algorithmic models may not always behave as intended under extreme market conditions.

In summary, stablecoins offer a novel opportunity for those looking to minimize risk in the volatile crypto market. However, the debate around their long-term value and security persists, and investors are encouraged to weigh the benefits of stability and utility against the challenges of regulatory scrutiny and the inherent risks of the evolving crypto landscape.

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