Continuing our exploration of individual decentralized finance applications, we’re going to look into what stablecoins are and then weigh their pros against their cons. In the end, you’ll know exactly where these assets can fit in your decentralized finance strategy.
This is the third installment in the Intro to Decentralized Finance series. If you haven’t already, we recommend going back and reading the first article, as everything else builds upon it.
Without any further wait, let’s jump down the rabbit hole of stablecoins and see what the buzz is all about.
Table of Content
- A Quick Overview of Stablecoins
- The Pros of Stablecoins
- Volatility Resistant
- Trustless
- Designed for Daily Use
- The Cons of Stablecoins
- Centralized
- Potential for Collapse
- Should You Use Stablecoins in Your Portfolio?
- Key Takeaways
A Quick Overview of Stablecoins
As the name implies, stablecoins bring some much-needed stability to the world of decentralized finance.
Due to the uncapped volatility of normal cryptocurrencies, many people see them as nothing more than a vehicle for speculation. The assets in this emerging new area of finance can do double-digit price dances in a matter of mere hours and days.
Stablecoins, on the other hand, can go through the thick and thin times of the cryptocurrency markets without any major shift in their pricing. That’s because these assets are pegged to a fiat currency like the USD.
The creators maintain this peg by backing each unit with the equivalent of one US dollar. Although there have been many controversies that cast doubt over this claim, as we’ll see later in this article.
In short, stablecoins bring the best of both traditional and decentralized finance together into a unique offering. These novel cryptocurrencies are as stable as government-backed currencies while still retaining the many benefits of blockchain and decentralized finance.
Examples of the most popular dollar-pegged stablecoins include USDT, BUSD, and USDC.
The Pros of Stablecoins
This unique blend of traditional and decentralized finance carries many benefits with it. Let’s explore some of them below.
1. Volatility Resistant
It goes without saying that stablecoins are resistant to the extreme volatility associated with other blockchain-powered assets. Whether the market is in a roaring bull run or a depressed bear state, the value of a stablecoin remains the same.
2. Trustless
At the same time, stablecoins leverage the same blockchain technology to bring trustless transactions to the masses. Everything is still automated through smart contracts (blockchain code).
As a result, these assets offer privacy to both senders and receivers. The only information you must disclose is the wallet address. Everything else is optional and agreed upon by both parties.
3. Designed for Daily Use
Bitcoin and Ether, two of the most popular cryptocurrencies on the planet, are incredibly unfriendly to daily users. Bitcoin transactions can take half an hour to process and typically carry a cost of several US dollars. Ethereum fares even worse as transactions can take hours to process and costs can climb as high as $80 or even more during times of network congestion.
Stablecoins, on the other hand, can process transactions much faster and affordably. For instance, BUSD is a stablecoin by a cryptocurrency exchange called Binance. Powered by their proprietary blockchain called Binance Smart Chain, BUSD transactions can process almost immediately and cost less than 1 cent in most cases.
Of course, we can’t discount the fact that these cryptocurrencies are priced at a stable one-dollar value. As a result, people can exchange value without worrying about price fluctuations.
The Cons of Stablecoins
As with anything else in life, stablecoins come with their own suite of drawbacks. Let’s look at some of the most important ones below.
1. Centralized
As a central authority controls the software and the entire treasury of assets that are used to peg these cryptocurrencies, stablecoins are as centralized as a crypto token can get.
However, most people don’t seem to care about the centralized aspect of these assets. As of this writing, two of the top five cryptocurrencies by market cap are USDT and USDC, both centralized stablecoins.
The bottom line is that while these assets have held their value to date, there’s plenty of room for foul play because the power resides in the hands of central authorities managing these dollar-pegged cryptocurrencies.
2. Potential for Collapse
We’ve seen stablecoins hold their value throughout multiple market crashes at this point. But that doesn’t mean that they’re bulletproof and fully resistant to market dynamics.
The centralized nature of these assets makes them even more vulnerable, as any foul play on the part of the creators could lead to a complete wipeout of value. For instance, the creators of Tether (the most popular stablecoin) made headlines last year after it was found that they don’t maintain an exact one-to-one ratio of US dollars in their treasury.
In fact, the company shifted its position to claim that it only holds 2.9% of the value in US dollars that it’s minted in terms of stablecoins supply. With minimal regulatory oversight, we’re dependent on the integrity of these centralized creators, which means there’s always room for collapse and loss.
Should You Use Stablecoins in Your Portfolio?
As you’ve seen, stablecoins are far from flawless. But where they excel is in terms of serving as a safer shore for your portfolio during times of excess volatility.
For instance, if you’re happy with the price appreciation of a decentralized asset from your portfolio, you can lock in on the profits by converting it into stablecoins. This way you won’t have to convert your assets back into USD or any other fiat currency. The next time you want to get in on another trade, you’ll be able to pay with your stash of stablecoins.
In essence, stablecoins can help you cut banks and other traditional finance entities out of the equation during your cooldown periods.
Key Takeaways
Here are the key takeaways from today’s article:
- Stable coins are pegged to fiat currencies like USD, making them resistant to the volatility of cryptocurrency markets
- The centralized aspect makes stablecoins vulnerable to collapses as the actions of the central authority can and will affect your portfolio
- The best strategy is to hold your cryptocurrencies in stablecoins when you want to take a temporary break from decentralized finance
