The cryptocurrency market is renowned for its high volatility. In doing so, gaining or losing 60% of your capital in just a few days becomes routine for insiders. Subject to the law of supply and demand, all cryptocurrencies experience more or less significant fluctuations. This unflattering characteristic is one of the causes which explains the negative criticism made towards cryptocurrencies. It is therefore with the aim of solving this problem that stablecoins were created. But what is a stablecoin? This is precisely what we are going to discover.
Is market volatility harmful or beneficial?
Even if the strong variations in cryptocurrencies may seem aberrant to us, you should know that these are, for many, opportunities to make huge gains. But you still need to have the technical skills, as well as the psychological skills, necessary to seize these opportunities. As stated at the beginning of this article, the only ones who are accustomed to the incessant fluctuations of the cryptocurrency market and who manage to profit from it are the insiders.
The Holders
Among these initiates, there are the “Holders”. Which we define as long-term investors, who will end up selling their cryptocurrencies within ten or even twenty years. Based on the principle that the latter are destined to increase in value in the future, the Holders do not care about the way in which the market evolves in the immediate future. So much so that if it were to drop drastically, they would take the opportunity to position themselves more and wait patiently for the market to rise again. Holders can thus be described as passive investors.
The Speculators
At the same time, the actors who could be described as active investors are seasoned speculators. These are people who regularly buy and resell cryptocurrencies, in order to promote their returns. On the lookout for what is happening on the market, their operations (purchase/resale) take place
in order to try to predict what the market will do.
Depending on the risk that speculators take with regard to a cryptocurrency, they can make a significant capital gain. For example, a speculator places a significant amount of capital (let's say an amount he cannot afford to lose) on an unsavory cryptocurrency (let's say a shitcoin). Eventually, the cryptocurrency in question explodes upward. Our speculator will receive a gain comparable to the risk he took, if his anticipation had not come true.
This explains why it is good for seasoned speculators to enter the cryptocurrency market. This market being much more volatile than the stock market, the earning opportunities (example: +50% on a crypto) are more interesting. So much so that there are thousands of people who have become rich thanks to cryptocurrencies. But as you can imagine, conversely, the probabilities of loss (example: -50% on a crypto) remained very high.
The Traders
Just like speculators, Traders operate in the cryptocurrency market in order to try to predict what the latter will do. Here again, they will receive a gain comparable to the risk they took, if their anticipation had not come true.
The difference here is in terms of time. Traders operate on the market much more often than speculators. And just like these, a volatile market means opportunity. Added to a more or less significant leverage effect, many Traders have enriched themselves on the fluctuations of cryptocurrencies.
Winning is one thing, but securing is another
As you may have noticed, some players manage to take advantage of market variations. But note one thing. The profits they make are in cryptocurrency. What is the downside to this? Earning money is one thing, but securing it is another.
In doing so, if a speculator wishes to secure a gain that he has managed to make on the market, he will very quickly realize that keeping it in the form of cryptocurrency is not at all practical. Because remember, cryptocurrencies are volatile. If your capital gain for the month were to lose 50% of its value in the space of an instant, you would be disgusted.
Secure in fiat currency
Following the problem stated above, concerning the lack of practicality for securing your gains in cryptocurrencies. We can say that it is therefore preferable to convert your winnings into fiat currency. That is to say in euro, dollar, pound sterling, etc. However, the problem with this practice this time comes at the tax level.
Indeed, in most countries, all gains made in cryptocurrency, then converted into fiat currency, are taxable by the State. Some will say that this is the price to pay to secure your crypto gains. But unfortunately, the price to pay is far too high. It is therefore to solve both a problem of security, but also of taxation, that stablecoins were created. But what is a stablecoin? We're finally going to get there.
What is a stablecoin?
As its name suggests, a stablecoin is a so-called “stable” cryptocurrency. The idea behind this concept is to limit the uncertainty found in cryptocurrencies due to their volatilities. To do this, it was decided to create a digital asset backed by traditional currencies (dollar, euro, pound sterling, etc.).
Being currencies regulated by central banks, there is no chance that they could lose 50% of their value overnight. Which makes fiat currency the ideal choice for stabilizing a digital asset. Consequently, if a speculator makes a profit on the evolution of a cryptocurrency, he can secure his profit by converting it into a stablecoin.
Since stablecoins are decentralized, their added value cannot be imposed by the State, unlike the euro. It will thus benefit from the stability of stablecoins, while avoiding taxation of its profits. Even if stablecoins have the same purpose, which is to ensure the stability of a digital asset, you should know that they each have very different mechanisms.
The different types of stablecoins
Centralized stablecoins
The stablecoin model presented above (a crypto backed by a fiat currency) means that the entity issuing the stablecoin must hold it in a bank account containing the value of the stablecoin issued in fiat currency. For example, in order to put into circulation a stablecoin backed by $10 million, the entity in question must have $10 million in its bank account. So that 1 stablecoin is equal to 1 dollar.
The largest dollar-backed satbelcoins, by market capitalization, are: USDT, USDC and BUSD. The letters found at the end or beginning of the dollar (USD), represent the company that manages the associated stablecoin. In the case of USDT, Thether Limited, a subsidiary of the Bitfinex platform, is responsible for its management. Hence the letter T at the end.
USDC is managed by the Center Consortium, a consortium founded by Coinbase, one of the world's largest cryptocurrency platforms, and Circle, a digital finance company that provides financial infrastructure for businesses. Finally, BUSD is controlled by Binance, another leading cryptocurrency platform in its market, and Paxos, a blockchain-focused financial and technology agency.
Decentralized stablecoins
Here, instead of stablecoins backed by traditional currencies (EUR, USD, GBP, etc.), they are backed by cryptocurrencies. In doing so, this type of stablecoin is not governed by any central entity. For example, the largest decentralized stablecoin by market capitalization is DAI. It was developed by a decentralized autonomous organization (DAO) called MakerDAO.
So, one unit of DAI is worth one dollar, entirely backed by cryptocurrency reserves. A reserve equal to the number of stablecoins issued on the market. But in situations where the market is likely to fall, cryptocurrency reserves are often greater than the number of stablecoins in circulation.
Decentralized algorithmic stablecoins
This type of stablecoin is not based on the US dollar or cryptocurrencies. In order to maintain its value at a stable price, it relies on an algorithm whose function is to reduce or increase the supply of stablecoins in circulation. A bit like a central bank, regulating inflation and deflation.
When the value of a stablecoin tends to fall, following too much supply on the market, the algorithm automatically deletes stablecoins. This way, it will reduce the number of stablecoins in circulation and bring back the value that was previously lost.
Conversely, if the price of stablecoins increases due to scarcity of supply, the algorithm will issue new stablecoins. This is with the aim of reducing its value and bringing it back to its original price. Thus, a decentralized algorithmic stablecoin adjusts to the slightest change in price to maintain its parity with the US dollar.
