What are Stablecoins and The Risks Involved.

When people talk about cryptocurrency, the majority consensus is that it is a highly volatile and risky asset class that can make you a millionaire overnight or if you are not careful, turn $10,000 into $1 in a matter of minutes, just like the TITAN fiasco that happened a few days ago.

While I agree that cryptocurrency in itself possesses a risky nature, there are some ways that you can mitigate the main risk of dips in the market and capitalize during bull runs.

Introducing Stablecoins!

What are Stablecoins?

Stablecoins are a class of cryptocurrency that offers investors stability in the extremely volatile cryptocurrency market by being pegged to a national currency and backed by a or several reserve assets.

They may or may not be pegged to relatively stable assets and are as follows:

• Fiat-backed (collateralized)

• Crypto-backed (collateralized)

• Commodity-backed (collateralized)

• Algorithm-run (non-collateralized)

For algorithm-run stablecoins, it is akin to the mechanism of a central bank. The latter mints banknotes and coins to preserve national currency value and if supply is higher than demand, they basically give you a share of 'future money' that you will be entitled to withdraw once demand becomes higher than supply again.

Banks basically loan you money that they don't have and you to pay interest, to eventually have that money.

In simpler terms, take loans for example. Loans are usually only given out to individuals with good credit scores and most importantly if they are able to provide collateral for those loans in the unlikely event that they do not return the borrowed capital.

This is a risk-mitigating factor that lending institutions like Hodlnaut practices to make sure that the business still remains stable without any downtime - despite the loss of funds.

Similarly, Stablecoins can achieve stability because they are collateralized through the algorithmic mechanism of buying and selling through their pegged asset or commodity.

Are Stablecoins risky then?

We now know that Stablecoins are able to provide investors with stability in the volatile cryptocurrency market, and would be tempted to move our entire savings into the asset class to take advantage of certain investment options that allow us to easily beat traditional bank interest rates (see here for OCBC's interest rates. OCBC is one of Singapore's largest banking providers) by almost 10 times!

However, no matter how 'stable' an asset class claims to be, there will always be associated risks to consider when investing.

For Stablecoins, there are two risks that you should consider when putting your money inside. They are:

• Volatility of the Underlying Assets

Crypto-backed Stablecoins are subject to major shifts in the cryptocurrency market. DAI is one such example that has two different classes, single-collateralized and multi-collateralized. Single-collateralized DAI is backed mainly by Ethereum (ETH), while multi-collateralized DAI, like its namesake, is backed by multiple crypto assets that are on the Ethereum ERC-20 network.

For example, Ether (ETH) lost almost half its value in November 2018. If the MakerDAO system wasn't robust enough to handle sudden downward pressure like this, it would result in the recent TITAN rug pull that saw the value dropped from $60 to $0.001 overnight.

• The Difficulty to Maintain a Perfect Peg

Following from the previous point, it is inherently tough to constantly maintain a perfect peg due to the rise and falls in the market. That is why you will sometimes see stablecoins like DAI, USDT and USDC over or under the US Dollar by 1 or 2 cents. For example, if the stablecoin drops to $0.75, this will mean that supply is higher than demand and the algorithm will buy back that amount to bring the value back as close to $1 as possible.

Algorithm-backed stablecoins rely on the future demand of these coins themselves and it is important to note if there is no future demand, the price will crash and inadvertently invalidate the coin

Ending thoughts

It will be foolish of me to argue against investing in stablecoins because of the surge in demand due to the recent crypto market crash. Additionally, stablecoins allow investors the opportunity to beat the traditional bank interest rates and easily earn a passive income while they diversify into other investment options.

However, it is crucial for everyone to understand that with every investment comes the inherent risk that they need to take note of. Remember the old saying, 'Do not put all your eggs in one basket?'

The analogy applies here because as safe as an investment option can get, it is crucial to not go all-in into it because you will face the risk of losing everything at one go. Instead, look into diversifying your assets so that you can rebalance your portfolio if in any event, an asset class that you have invested in faces a relatively huge dip.

That being said, there is some money to be made through CeFi interest-earning platforms like Hodlnaut, Celsius and Nexo. Individuals can also look into different DeFi Protocols that have astronomical returns on stablecoin pairings. If you are interested, you can gain some bonuses when signing up for the first time on these platforms by using my referral links below.

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