How to Use Stable Coins

You’ve probably heard about them with the response being only to ask yourself how to use stable coins. There are actually advantages that become clear the first time you buy some USDC or USDT and Bitcoin dips to a new weekly low. Stable coins are easy to liquidate during market volatility to preserve asset value and grant peace-of-mind.

Benefits of knowing how to use stable coins include being able to:

  • Explain the way cryptocurrency works more easily by using stable coins as an educational bridge
  • Instantly sell cryptocurrency for stable coins and quickly trade to fiat, without leaving your preferred exchange
  • Protect your assets using strategies that focus on hedging and harvesting, or stopping loss

What are the different Coins that can be used?

The most popular stable coin currently has been around since 2015 and is distributed by Bitfinex, a company that is not decentralized. USDT (Tether) has achieved top-20 status by market cap and offers liquidity to crypto exchanges because it is backed by USD on a 1:1 ratio. USDT can be used as an alternative to BTC when trading on exchanges as it works on the Bitcoin blockchain.

TrueUSD is also backed by USD and works on the TrustToken platform that bridges real-world assets and Blockchains. It has legal protection having been verified by third-party attestations and can be exchanged into USD directly with an escrow account and redeemed by those passing a standard KYC/AML check.

A more innovative approach was taken to make the DAI stable coin. It works like the USDT and TrueUSD and is valued against the USD, but not backed by USD. It is backed by Ethereum Blockchain and is a crypto-collateralized stable coin.

USDC (USD Coin) launched by Circle and Coinbase collaboration, and based on the open-source asset-backed stablecoin framework developed by CENTRE, is another alternative. The service tokenizes US dollars and facilitates their use over the Internet and public blockchains. USDC can be changed back to USD at any time, with the execution of the tokens ensured with ERC-20 smart contracts. Centre, the consortium that mints USDC, collectively holds $1 USD for every single USDC in a special bank account that is constantly monitored and audited. It can also be traded on exchanges such as Coinbase, Coinbase Pro, Poloniex, Binance, Bitfinex, Changelly, and more. It is the only stable coin regulated as a registered Money Services Business under U.S. money transmission laws. It should also be noted that users need to hold ETH in order to cover transaction fees incurred for USDC. This is not the case for USDT (Tether).

There are other coins available and every user should research the type to determine if there are solid backers and audited reserves before using stable coins. For example, a major difference between other asset-backed stable coins and USDC is the attempt to follow existing U.S. guidelines at every step.

“USDC is issued using the CENTRE open source framework and membership scheme, and it is available as a framework that multiple companies can leverage. Eventually other financial institutions will be able to become USDC issuers (and issuers of other fiat stablecoins – e.g. EURC, JPYC, GBPC), and customers will be able to tokenize USD and redeem USDC tokens in an open and interoperable ecosystem of financial institutions. A membership governance model for issuers shall ensure that they meet technical, operational, regulatory, compliance and audit requirements.”

What are Stable Coins?

Before you can develop a strategy for how to use stable coins, it is important to understand what they are. This new class of cryptocurrency exists to offer price stability by being backed by a reserve asset. They come in different sizes and qualities, but they are all collateralized and most stay close to the value of one dollar – referred to as being “pegged to the dollar.” Other collateral can include precious metals like gold or silver, as well as commodities such as oil, as a peg. Sometimes stable coins become “off their peg” by a few points. This can be a cataclysm happening in the market, or it can be an inefficiency that can present an opportunity to profit before the coin returns to its peg. Offering the best of both worlds, stable coins allow instant processing and security or privacy of payments PLUS a volatility-free stable value.

Stable coins provide a solution to simulate the ideal behavior of stability and maintaining purchasing power that the most popular cryptocurrencies do not yet possess. Controlling authorities, like central banks, manipulate supply and demand of fiat currency which keeps it free from the wild-west swings seen by crypto. Cryptocurrencies do not have a reserve (whether real or perceived) backing valuations, and there is no central authority to control prices. Stable coins can be used to bridge the gap between the unique qualities of crypto and those fiat qualities some wish crypto had. Stable coin reserves are maintained by independent custodians that are regularly audited for compliance and to ensure a 1:1 ratio is being maintained.

There are also crypto-collateralized options which are, of course, backed by other cryptocurrencies. However, this seems redundant and one might question the wisdom of stable coins secured by unstable coins? Since all cryptocurrencies are prone to high volatility, double the amount of the uncollateralized stable coin’s worth must be held in the underlying peg coin as reserves to help hedge against 50% market price swings. There are also non-collateralized, or algorithmic, stable coins which use a mechanism to increase or decrease the supply needed by using smart contracts on a decentralized platform running autonomously.

What USDT, USDC are not.

While stable coins are pegged to fiat for stability, make no mistake – they are not linked or controlled by any bank or Government. They can be regulated by the U.S. Government regulations to be properly collateralized, such as USDC or Gemini Coin, but they are cryptocurrency nonetheless. USDT’s closest competitor is currently USDC from Circle/Coinbase. Many traders have not made the switch from using USDT to USDC because some are not interested in well-behaved, fully collateralized stable coins – but that could change if USDT falls under greater scrutiny in the future.

The most important thing to know about stable coins is that if you buy, say with Bitcoin, and the BTC price goes down, your stable coins remain worth what you paid in USD value. However, if BTC price goes up, your stable coins remain worth what you paid in USD value also. The difference is that you are still holding cryptocurrency and can quickly and easily convert back to BTC if the price appears to be on the rise. For those inexperienced traders, USDC is the regulated, audited option – not USDT (Tether).

How the use of Tether or USDC affects crypto-fiat transactions?

There has been some concern that non-native token use outpacing the native unit by a high factor could be problematic. Currently stable coins account for a relatively small albeit growing share of on-chain transactions. Most transactions occurring are still that of ETH, BTC, LTC, and other top cryptocurrencies, while other token transfers have lessened. However, the actual value of transactions on the Ethereum blockchain appears to be dominated by crypto-fiat in dollar terms. Tether, USDC, BUSD, and DAI are beginning to account for a large amount of value transacted and are starting to be viewed around the world as non-bank dollar alternatives to settle thousands of dollars worth of value.

That said, the actual number of people using stable coins is still small. Existing data indicates this small userbase is actively embracing stable coin use for quite larger transactions. It is easy to imagine this trend could catch on quickly as more understand how to use stable coins. It is worth pondering whether stable coins that require ETH be held in order to pay fees could be displaced in the future by those that simply allow payment of fees with the same tokenized USD coin being used to transact. By the same token (pun intended) fiat-based stable coins face legal and regulatory issues that may yet to be on the horizon, as well as the need for banks and a benevolent issuer. There will always be a need for truly liability-free, native crypto coin use on-chain.

How to Protect Assets?

How To Use Stable Coins to Protect AssetsLearning how to use stable coins to protect your assets could be valuable knowledge. Stop-Loss, Hedging, and Harvesting strategies can help you make good decisions when markets move in adverse directions. For less experienced traders, the easiest way to “stop loss” in a volatile market is to simply exchange digital currency for stable coins. It happens quickly, easily, and instantly to freeze the value of your assets. During times when Bitcoin price is changing 10% to 20% or more in minutes, the stress over one’s portfolio can be enormous. That typical 10 minutes to transfer funds from one exchange to another, or even longer when the mempool is jammed up, can mean a significant loss just waiting for confirmations.

Knowing how to hedge and harvest can save a trader a good deal of loss. A “hedge” is an investment to reduce the risk of volatile price movements in an asset. The use of stable coins as a method for managing a safe, effective increase in profits that saves time, exchange fees, transfer charges, and transaction costs is a great strategy. The “harvesting” method is commonly referred to as an exit strategy, as investors seek to exit the investment after its success. Investors will use a harvest strategy to collect the profit from their investment so it can be reinvested into new ventures.

“Hedging and harvesting” simply put means trading fluctuating crypto into stable coins as the market dips to secure more bitcoin (for example), and reinvesting profits as prices rise to rebalance the portfolio.

Can Stable Coins be used to Trade Profitably?

Once you become familiar with how to use stable coins in transactions, you will quickly see how easy it is to hedge and harvest using stable coin vs. conversion from or to fiat. We’ve all been there – constantly refreshing the page to check confirmations of a BTC transfer, or counting the minutes for fiat to be deposited into our exchange account. An hour or even less can sometimes be the difference it takes to miss a great trade.

Tokenized assets are not without issue even if you know how to use stable coins. While a convenient tool, consider that they can be frozen by their issuers, as they are not decentralized assets. Stable coins settle through the traditional financial system, are not censorship-resistant, and are not bearer assets. So a full understanding of their value, as well as knowing when and how to use stable coins is essential. In contrast, BTC is a zero-trust asset when settled on the Bitcoin network. Settlement in Gold is also trustless, but only when transferred from one person to another physically. Since the trustless-ness of gold is limited to physically held bars or coins, and stable coins can be confiscated, all in all BTC should prove to be more useful by far in the emerging digital economy.

Are Stable Coins Safe?

Not 100%, no – because the risk is directly related to the stable coin’s underlying asset. The safest two are considered to be the only two currently regulated stable coins: Gemini Dollar and Coinbase’s USD Coin. These are the only two that are regularly audited and backed by a relatively stable fiat currency, the USD. If one seeks to hedge against a market crash, these two are the least likely to crash and burn – at least for the time-being.

Hedging

Balanced Portfolio

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Bitcoin

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Portfolio $1,000

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Stable Coin

Bitcoin Price Drops 20%

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Bitcoin

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Portfolio

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Stable Coin

Rebalance Portfolio

BTC bought instantly on the same Exchange at a lesser price using Stable Coins balance

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Bitcoin Buy $50 worth

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Portfolio $900

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Stable Coin Sell $50

Harvesting

Bitcoin Price Increases 20%

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Bitcoin

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Portfolio

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Stable Coin

Rebalance Portfolio

BTC sold instantly on the same Exchange at a higher price for increased Return on Investment (ROI)

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Bitcoin Sell $50 worth

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Portfolio $1,100

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Stable Coin Buy $50