How to trade stablecoins safely on Liquid

In Trading Strategies, Crypto Spotlight, Announcements

The supply and overall volume of stablecoins has been on the rise recently — even more so with the newly found interest in digital currency of the U.S government. Earlier this year, the Federal Reserve announced that it was considering issuing its own digital currency. Federal banks have already been authorized to hold stablecoins in bank reserves. Who knows if a stablecoin called Fedcoin is coming on the way? Similarly, the European Central Bank might seriously study the possibilities of the digital euro by mid-2021 as well as ways to integrate it into the current Eurosystem. 

If a final decision is to take place by the governments, stablecoins are expected to boost the spread and efficiency of e-commerce and potentially reshape the current economy. Read on to discover why stablecoins are gaining so much attention, and how you can start trading stablecoins on Liquid. 

What is Stablecoin? 

Stablecoin is a class of cryptocurrencies whose market value is backed by a reserve asset. The price reference is typically hard currencies, such as USD and EUR, or gold. Stablecoins are essentially the digital version of real life assets by having their value mimic that of traditional and stable assets. Most stablecoins operate on the Ethereum network as ERC20 tokens, for instance, USDT, USDC and DAI. 

As blockchain technology is still in its infancy, the significant volatility in valuations of cryptocurrencies, such as Bitcoin and Ethereum, hinders them from being adopted into daily financial  transactions. Stablecoin has the potential to become an optimal solution to this issue by combining the benefits of both cryptocurrencies and fiat currencies. It possesses perks of instant processing speed, minimal transaction fees, security and decentralized privacy of cryptocurrency while having its values free from considerable price swings in the crypto market. Traders who want to enjoy the decentralized financial independence it brings, but wish to avoid the volatility of crypto assets might find stablecoins what they are looking for. Traders can also choose to move their funds and investments from volatile crypto assets into stablecoins while remaining in the crypto ecosystem and avoiding paying hefty charges to switch back to fiat currencies. 

In the future, stablecoins are also expected to become the go-to financial technology that will benefit millions of people in countries with economic uncertainty. Stablecoins will allow them to have access to secure savings and funds in the form of a global digital currency and free them from worries caused by their unpredictable local economy. 

Inside the Stablecoin Family 

Stablecoins are different from one another by their configuration as well as behind-the-scenes mechanisms that are adopted to stabilize the price. Knowing the differences among these types can help you select the right one for your stablecoin trading and investment purposes. 

  • Asset-backed stablecoins 

The most common type of asset-backed stablecoins is fiat-backed (also called fiat-collateralized) stablecoins. They are backed to fiat currencies at a 1:1 ratio, meaning one stablecoin has the same value as one currency unit. A central issuer behind the token is required to hold the amount of fiat currency behind stablecoin tokens. Holders of the issued stablecoins can trade them with fiat currencies or cryptocurrencies, as well as redeem them for an equivalent amount of fiat anytime. 

For instance, USDC issued by Circle are pegged to the value of the US dollar and British pound, respectively. Another well-known token in stablecoin trading is Tether (USDT), which is also backed by the US dollar and has the second highest trading volume following Bitcoin. Recently, however, Tether has been raising red flags it is suspected to release more USDT than the amount of fiat reserves that it actually holds. As a result, other fiat-backed stablecoins, in particular USDC is on the rise in terms of popularity as an attempt to topple the leading position of USDT.

A second type of asset-backed stablecoins called crypto-backed stablecoins is also in circulation. In this case, another cryptocurrency is used as a collateral to the stablecoin. In order to account for possibilities of high volatility faced by the reserve cryptocurrencies, more cryptocurrency tokens are available in reserve than the actual number of stablecoins issued. In other words, crypto-backed stablecoins are over-collateralized.

Instead of being issued by a central issuer or a bank, crypto-backed stablecoins are issued by smart contracts and run entirely on the blockchain. As a result, processes behind transactions involving crypto-backed stablecoins are notably more transparent, trustless, and secure than those involving fiat-backed stablecoins. The monetary policy of crypto-backed stablecoins is not regulated by only one issuer, but by the agreement of all voters in their governance system who are expected to make decisions with the best interest of crypto holders in mind. Among well-known crypto-backed stablecoins, MakerDAO uses a smart contract on Ethereum blockchain in which MakerDAO’s DAI token is pegged to ETH. 

Last but not least, commodity-backed stablecoins are collateralized by stable assets, namely rare gems, gold, oil and real estate. Out of these types, gold-backed stablecoins are most commonly seen. While commodity-backed stablecoins are less prone to inflation than fiat-backed ones but also less liquid and harder to redeem. Paxos Gold (PAXG) is one example as a commodity-backed stablecoin as a ERC-20 token run on the Ethereum network. One DGX has the equivalent value as one fine troy ounce (t oz) of a 400 oz London Good Delivery gold bar. The actual gold behind PAXG in circulation is stored and held in custody by Paxos Trust Company.

  • Algorithmic stablecoins 

As the name suggests, algorithmic stablecoins are managed entirely by smart contracts and algorithms on the blockchain. In order to stabilize the price, the algorithms continuously adjust the supply of the tokens. Automatic algorithms make these stablecoins the most decentralized and stable among all types, but these mechanisms can be complex to design and implement on the blockchain. 

The monetary policy behind algorithmic stablecoins closely resembles the mechanism of national central banks used in stabilizing the value of their fiat currencies. When the price of the stablecoin rises above the price of the fiat currency it tracks, the algorithmic stablecoin system will automatically decrease the supply of tokens. Reversely, it will increase the supply of tokens when the price falls. 

Potentials and Limitations of Stablecoins 

Stablecoins are expected to become the solution to the high volatility in prices of cryptocurrencies, making crypto tokens more accessible and friendlier for daily financial transactions in the future. Stablecoins can also be utilized to gradually merge cryptocurrencies with traditional financial markets and bridge the gap between these two separate ecosystems. In addition, traders and investors use stablecoins as a useful hedge in their crypto trading portfolio. This trading strategy contributes to lowering the risk in purchasing cryptocurrencies and protecting the value of the investments.

Loan and credit markets are likely to see a rise in the usage of stablecoins and cease to be dominated by government-issued fiat currencies. Stablecoins pave the way for the usage of automatic smart contracts on the blockchain network and enable transparent, fast and traceable transactions during loan payments and subscriptions. 

Like everything else, however, stablecoins face a few drawbacks. As their value is pegged to another asset, fiat-backed stablecoins enjoy less decentralization than other cryptocurrencies as they are subject to the regulations of fiat currencies. As fiat-backed stablecoins are pegged very closely with their underlying assets, they risk crashing in case the macroeconomy enters a recession. Traders need to place their trust in central issuers or banks that the issued tokens are fully and safely backed with fiat. If these issuers do not have sufficient assets at their disposal, traders might face the risk of not being able to convert their stablecoins back to fiat when in need. 

For crypto-backed stablecoins, token holders have to trust the unanimous agreement of all users on the system, as well as the source code. Having no central issuer or regulator can make crypto-backed stablecoins prone to the risk of plutocracy, which means the power of governance lies in the hands of those holding a large amount of tokens. Furthermore, the value of crypto-backed currencies is also less stable than that of fiat-backed stablecoins. In case there is a spike or drop in the supply of the collateralized stablecoin, the stablecoin will undergo drastic impacts as well, hence less stability in the pledge system.

Trading Stablecoins with Liquid

Traders are now able to move between popular cryptocurrencies and enjoy the liquidity of the stablecoins on Liquid. You can start trading stablecoins on our exchange platform with a variety of currencies to choose from: USDC, USDT, DAI, IDRT, SGR, RSR. For instance, among them are USD Coin (USDC) and Rupiah Token (IDRT). Both stablecoins are 100% collateralized to a corresponding USD and IDR respectively as ERC-20 tokens and can be stored in any Ethereum-compatible wallet. Liquid offers USDC, USDT, DAI, IDRT against BTC and ETH. USDC can be bought by traders as a means to protect their investments at times of price volatility. As fiat-backed stablecoins, USDC can be transferred over the blockchain with a high speed and a minor fee. As a result, moving USDC allows much more efficiency than moving fiat.

Another example is Sogur (SGR). It is a unique hybrid crypto asset that blends stability qualities of an asset-backed stablecoin with the potential for volatility found in traditionally-scarce crypto assets. SGR is reliant on the value of a trusted basket of currencies — replicating the composition of the IMF’s SDR (Special Drawing Rights), which has been successfully used for over five decades now by the world’s central banks as a stabilisation instrument. The SDR comprises of the USD, the Euro, the British Pound, the Japanese Yen and the Chinese Yuan, which makes it robust against price fluctuations caused by one currency.

Do you know that the repertoire of Japanese yen-pegged stablecoin is coming soon without the negative yield? The world’s first Japanese Yen stablecoins (GYEN), issued by GMO Internet, will soon be supported by the NYDFS and listed soon on our exchange platform. In addition, Japan’s largest banking firm MUFG is also going to release their digital currency, called MUFG Coin in the upcoming months of 2020. MUFG is placing cashless projects high in their list of priorities of digital strategy. Bitcoin applications in Japan are on the rise as Blockstream, a sidechain of Bitcoin is also catching up with the trend by releasing Japanese yen stablecoin (“JPY-Token”), possible for trading with bitcoin pegged to the Liquid sidechain (L-BTC). 

Liquid is also looking to add some of the other stablecoins like: Brazilian digital token (BRZ), Canadian stablecoin (QCAD), and Turkish Lira stablecoin (BiLira).

Don’t forget, market makers for altcoin and stablecoin pairs will be eligible for 2bps rebate. Check which pairs of altcoins and stablecoins are included!

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