Stablecoins play an important role in the cryptocurrency ecosystem by allowing a fiat currency such as the dollar to be transferred around the world via a blockchain. These stablecoins are either backed by a centralized third-party who claims to have the fiat, or equivalent, to back each token they provide or the stablecoin is backed by a decentralised algorithm. Luna and UST are examples of the latter.
Luna is a cryptocurrency designed to back the stablecoin UST. The idea was that the supply of Luna would be regulated in such a way as to keep UST at $1 per token. Unfortunately, this failed and the peg was broken. Luna went from over $100 per coin to less than 1 cent. UST, which is meant to always trade at $1, was at less than $0.10 at the time of writing.
Many people lost huge sums of money that they believe they had safely stored as digital dollars. For some this will have amounted to their life savings and will be devastating to their lives. Let’s explore why people are using stablecoins, the risks involved and why I believe real estate may be a good alternative to some stablecoin use cases.
1. Why use stablecoins?
There are a number of uses of stablecoins. Some cryptocurrency traders simply use them as a means of holding cash while the cryptocurrency markets are down. This allows them to quickly buy back into Bitcoin and other digital assets without having to wait for a bank transfer to come through. This allows crypto traders to react quickly in changing market conditions.
Another use for stablecoins is as a means of saving. Mainstream banks are offering interest rates of less than 1%, and inflation is rising. Inflation is even higher if you base the rate of inflation on the amount of money that is being digitally printed, as many cryptocurrency enthusiasts do. This means that if you keep your money in a bank, it is losing value overtime.
With stablecoins, there are a range of centralized companies and decentralized protocols that offer much higher rates of interest. With the UST stablecoin, it was possible to earn up to 20% per annum. This is a far more attractive way to hold cash for those worried about the rate of inflation. Many investors use this method to save for the long term and mitigate the volatility of the wider cryptocurrency market. This allows cryptocurrencies to play a key role in the ecosystem of digital assets.
2. What are the risks of using stablecoins?
There are two primary types of stablecoins, centralized and decentralized. Both come with a set of risks. Centralized stablecoins are tokens issued on a blockchain that have a centralized third-party, such as a company, backing them. This third-party promises that each coin they issue is backed by money in the bank or by assets such as bonds. Holders of such stablecoins can redeem the tokens for the currency backing it by going to this issuer and meeting certain conditions. Mostly, however, these tokens are just traded peer-to-peer on exchanges.
The risk of a centralized stablecoin is that it may not be fully backed. An issuer of a stablecoin could be tempted to issue tokens that it does not have backing for given the fact that all the tokens are unlikely to be redeemed at one time. Furthermore, even if the token is fully backed, there are regulatory risks. If a government objects to the issuer of the stablecoin, they could freeze the money backing the coins. Either of these scenarios could lead to a stablecoin losing its peg and being worth less than $1.
The other approach is a decentralized, algorithmic stablecoin. These are programmed coins that are meant to be pegged to $1 via backing by other assets. This backing is adjusted on the blockchain by a bit of code known as a smart contract. The problem with this type of stablecoins is that it requires the programmers to see all possible eventualities in advance and not to make any mistakes. When things go wrong, like with UST, things can go very wrong indeed.
3. Using real estate instead of stablecoins for long-term savings
Stablecoins are very useful, but I wouldn’t risk my entire savings pot with them. I also wouldn’t store my wealth in the bank and allow inflation to eat it away. So what is the solution? For me, real estate. There is a limited supply of land and an increasing supply of people. All those people need to be housed. This means that capital appreciation protects you from inflation, while you can earn the equivalent of interest on your savings paid for by the rent paid by tenants.
I live and invest in the U.K. where land is particularly limited. The U.K. is also a popular place to migrate to. Property rights are protected by the law, and U.K. real estate is a historically proven, safe way to hold your wealth. Property also allows you to use leverage safely in the form of a mortgage, meaning you can make your money go much further.
If I had a large pot of money in stablecoins right now, which I intended to keep for the purposes of long-term savings, I would certainly take some of that money and invest in real estate. Using the correct strategies, there are many ways to get much better returns on investment than you can with stablecoins and with less risk. Whatever you decide to do, it is important to understand the benefits and risks of each approach and to diversify accordingly.