Table of Contents:
- How do I manage risk in Cryptocurrencies?:
- Do Stablecoins make sense?
- Apart from Inflationary Risks:
- I bought Stablecoins: What now?
- Stablecoins for Day-Traders:
- Stablecoins for Crypto-Believers:
- Here's what others have to say
- Stablecoins: A Bright Future
With the markets crashing recently, and the general volatilities synonymous with the cryptocurrency market, the one question on every crypto-curios mind is:
How do I manage risk in Cryptocurrencies?
Managing risk in conventional finance is simple: You simply fill your portfolio with instruments of different volatilities (balancing your portfolio beta).
You add high-risk securities like Options to your portfolio, but balance it out with a lower risk asset, like a Government Bond at the Risk-Free Rate.
Such ‘insurance’ in traditional markets is what makes them seem like better investments. The supposed lack of such hedging instruments is exactly what makes cryptocurrency markets seem unpredictable compared to real markets.
So, what if we told you that you could, in fact, hedge risk in cryptocurrencies?
A Stablecoin is a cryptocurrency that is pegged directly with a real asset; maybe a currency, maybe gold and maybe even property! Since the values of real assets do not change as sporadically as digital assets, the values of stablecoins do not change with most of the market either!
An insight: On the 17th of December, the price of 1 BTC was at its peak at $19,535 and the markets were soaring! On the same day, the price of 1 USDT was still $1.01!
Today, when the price of 1 BTC is just $3,466; the price of 1 USDT is $1!
This shows just how irresponsive stablecoins are to the rest of the cryptocurrency market, once again, staking their claim as a truly stable asset.
Do stablecoins actually make sense?
In a market infamous for volatilities, the real question isn’t who needs stablecoins… it’s who doesn’t?
HODLers of BTC and other altcoins know all too well the pains that came with 2018. BTC, along with most other cryptocurrencies saw a drastic fall in value. All while coins like the USDT, TUSD, and GUSD barely fluctuated from their Dollar Standard.
Most developing countries have ‘fast-growing economies’, meaning that while jobs are being created and employment is on the rise, inflation is rising too. 100 INR last year, is worth 95 INR this year, an inflation rate of 5%.
More developed countries, however, like the USA and Australia have slower growing economies and hence, the value of 1USD will be close to the same next year, with an inflation of just 2.9%.
Now, while it would be impractical to stash away US Dollars under your mattress - with cryptocurrencies, you can buy US Dollars simply through your phone.
By purchasing USDT with INR, you not only directly convert your fiat to a “stronger” currency, you also hedge against inflationary risks without holding actual cash.
Other than hedging against inflation:
Apart from the obvious inflationary risks, there is one other key reason someone might want to hold stablecoins.
While countries like the USA have a free flow of capital in and out of the country, Chinese citizens face bigger challenges with free-flowing capital in and out of the country. A Chinese Stablecoin, if left to private forces, could succeed in scourging through fields of red-tape, and bring foreign markets to Chinese citizens.
Other countries that have restraints on flows of capital can also use stablecoins to bring global markets to their citizens.
In conclusion; stablecoins are one way of managing risk in cryptocurrencies. Now that we’ve told you about Stablecoins: Here’s a few you should look at:
1) Tether (USDT): Dominating the stablecoin market, and ranked #8 overall (according to market cap), Tether is firmly the most recognized and accepted stablecoin in the crypto-sphere.
As previously explained, each Tether coin is backed by 1 USD, held safely in a vault. When users want to exchange their USDT for fiat USD, their USDT is burned and the corresponding USD is issued.
2) DigixDAO (DGD): Unlike other stablecoins pegged with currencies, the DGD token is pegged with another stable asset - GOLD.
By using a unique consensus mechanism called Proof-Of-Asset (POA), the DigixDAO ecosystem confirms the possession of gold in their accounts and brings complete transparency to their users.
A stablecoin backed by gold will almost always bring long-run gains to your portfolio, the price of gold over the last few years exemplifies this, and gives you yet another reason to seriously consider adding the DGD to your portfolio, and maybe even HODLing long-term.
4) USD Coin (USDC): The USDC is, in most aspects, quite similar to the USDT; however, the one thing it does add is heightened security.
The Circle Network, the parent company to the USDC Protocol, regularly publishes audits and asset proof documents for the public to see, partially overcoming the scrutiny faced by USDT - doubts over if the underlying asset is secure.
I bought Stablecoins - what do I do now?
Now that you’ve bought USDT, DGD or any of the other stablecoins on the market, know that you have made the first step towards successfully hedging against market risks.
But this isn’t all - the main problem we face is that our portfolios sometimes lose value overnight, sometimes even 10% in a few hours! Listed below are a few tips to help you efficiently integrate stablecoins into your trading strategy.
As most people do, you can use stablecoins as a proxy to trading other currencies. These make accessibility to cryptocurrencies easier and allows for higher profit margins as you can trade more tokens, and even use arbitrage opportunities amongst different stablecoins.
When you’re done trading for the day, you can convert your altcoins into stablecoins to ensure they do not lose value overnight. While this protects you from quick drops in price, this strategy also prevents you from making passive gains. Such a strategy should only be employed after considering your perception of the market.
Then, once you begin trading for the next day, you can (if you employ this strategy) convert your stablecoins back into other altcoins and begin booking profits again!
If you, like many people, decide you want to trade in your downtime on the weekends, there is another strategy you can employ-
Similar to the strategy we suggested to day-traders, those preferring to trade on the weekends can also safeguard themselves against market risks by converting a percentage of their coins to stable-coins.
The remaining (say) 20% can be stored in coins with strong use-cases and future reliability, based on the investors’ preferences.
Here's what others have to say:
“As well as institutions coming in, stablecoins might be the key that unlocks the market,” said David Mercer, chief executive of LMAX exchange, a UK foreign exchange venue that trades $4tn a year.
“There’s no need to replace the US dollar that’s universally accepted,” said Chad Cascarilla, chief executive of Paxos, “You’re upgrading the way in which it moves rather than the value it represents.”
Stablecoins: A bright future?
As more people begin trading in cryptocurrencies, the use of stablecoins as proxies will increase, bringing more validation, and maybe even bringing a temporary marginal gain.
While some coins have very strong use-cases, the usability and even validity of stablecoins is perpetual and will last as long as real markets do.
A note to end on:
While stablecoins are mostly held at their value, due to them being backed by real-assets, they become susceptible to real-life problems of centralization and even financial market risks. However, these risks are usually market-wide and not idiosyncratic.