The global crisis is causing an explosive increase in demand for stablecoins. Some even say that it's stablecoins that will drive the mass adoption of crypto, not hypervolatile coins like Bitcoin. It's time to ask the question: which stablecoins will benefit more from the recession – regular ones, such as USDT, or decentralized ones, like DAI and others?
Back in March, when the stock market collapsed, BTC lost 40% of its value in just one day, and ETH lost 50%, only two types of assets were in high demand with investors: gold and stablecoins.
And while the surging demand of gold was reflected by a rise in its price, for stablecoins it was the circulating supply that was skyrocketing, since their price isn't supposed to grow by definition. According to CoinMetrics, the supply shot up by 40%:
Why such a high level of interest? First of all, during periods of uncertainty and volatility, investors seek to protect their capital and hedge the risks. This was stablecoins' original purpose, by the way: to give day traders a way to stash their intraday profits back when exchanges didn't support fiat withdrawals yet.
It's not just crypto investors who are buying stablecoins, but also fiat users who never owned cryptocurrency before. According to Circle, the demand for corporate stablecoin accounts has grown by 700% between March and April, with 70% of the new clients coming from outside the crypto industry.
Investors are attracted by the combination of reliability, liquidity, and mobility. Indeed, fiat USD are very liquid, but transferring them across borders isn't instant and definitely not free. Gold is very safe, but it's hard to buy and costly to store. Bitcoin is completely liquid, but unreliable. By contrast, stablecoins offer the best of all worlds.
Let's not forget about the ROI, either. You can place stablecoins in a deposit account and earn an interest, just like with a bank deposit. The rate can exceed 10% a year.
The problem is that only decentralized stablecoins can be considered truly reliable and safe; these are coins like USDN (Neutrino) and DAI. The idea that regular centralized stablecoins like USDT are safe is nothing but an illusion.
Before we consider the advantages of decentralized stablecoins, it's worth clarifying 3 points that often get beginner investors confused.
1) A stablecoin is any digital asset whose price is pegged to that of another stable asset. Most stablecoins are pegged to the US dollar, but it can also be euro or another fiat currency, gold, a commodity, or a basket of currencies.
2) For a stablecoin to maintain its value, it should be backed by some reserve asset, or collateral. This doesn't need to be the same asset to which the price is pegged. For instance, USDN (Neutrino) is backed by WAVES coins, and DAI is backed by ETH and other crypto. (There are also unbacked stablecoins that maintain their price with other means.)
3) A centralized stablecoin is issued by a specific entity, which is also responsible for storing the collateral. A decentralized stablecoin is issued by a smart contract.
When you buy USDT from the issuer (Tether), you transfer your dollars to Tether, which issues a corresponding number of USDT coins. Your dollars are transferred to a bank account where the rest of the collateral is stored. In theory, the total amount in Tether's accounts should be equal to the number of USDT in circulation, and the company shouldn't as much as touch the reserves.
The same should happen with gold-backed stablecoins: for each dollar you invest, the issuer is supposed to buy some physical gold and place it in a storage vault.
Ask yourself: how do you know that the stablecoins you hold are really backed by fiat money in a bank account? Can you be sure that the issuer didn't use the reserve funds for some other purpose?
The answer: you can't.
Moreover, there have already been cases when an issuer of a centralized stablecoin got caught meddling with the collateral. The most famous story happened in spring 2019, when it came out that Tether had transferred $700 million from its collateral accounts to its co-founder, Bitfinex. The latter then loaned the money to another partner, Crypto Capital, which failed to return it on schedule. In addition, shortly before the scandal broke out, Tether suddenly broke the contract with its auditors.
Pressured by the court, Tether admitted that only 74% of its coins are backed by USD, with the remaining 26% backed only by lines of credit. Who were the recipients of those loans worth over a billion dollars? The company wouldn't say.
Apart from the lack of transparency on the collateral, there's also the problem of contractual limitations. Centralized issuers like to talk about stablecoins as a universal currency for people all across the world, a hedge against hyperinflation, etc.
At the same time, the US-registered issuers forbid the use of their stablecoins in any territory that falls under a US embargo. These include Sudan, Cuba, Iran, Pakistan, and Syria. Incidentally, these are the countries where people really risk losing their savings to instability and inflation; and these are the countries that need stablecoins most.
Moreover, the issuer can forbid you to use its stablecoin for specific purposes. For example, the USDC terms of service state that the coin can't be used for any gambling activity, to pay taxes, refinance loans, and many other things. The company can annul the account of a user caught breaking the rules and even refuse to redeem their USDC for fiat.
Now let's look at the largest decentralized stablecoins: USD Neutrino and DAI. Their key advantages are three:
1) Transparency. New coins are issued as soon as collateral funds are added to the smart contract. Any user can verify that the collateral amount fits that number of coins in circulation.
2) Implementation of staking/decentralized deposits. Staking has become popular thanks to PoS coins like Tezos and Cosmos. Users earn an interest when they lock up their crypto in a smart contract. In the case of USDN staking on Waves.Exchange the ROI can reach 8-15% a year. For comparison: centralized crypto lending platforms like BlockFi offer no more than 8-8.5% on deposits in USDC and USDT. Plus, such deposits usually have a fixed term and cannot be withdrawn early without a loss. Meanwhile, one can release USD Neutrino out of staking at any moment and without a penalty. Moreover, Waves.Exchange allows users to buy USDN with a bank car with no fees.
3) Automatic price stabilisation. If the market value of the collateral falls, the smart contract takes action to maintain the stablecoin's price. USDN and DAI use different systems, but the result is the same: the price will remain at $1 even during periods of volatility.
The COVID-19 pandemic is forcing investors to look for new ways to protect their assets and increase their wealth. Stablecoins present an alternative to precious metals and volatile cryptocurrencies.
However, as we have seen, you can trust centralized 'digital dollars' only as much as you trust their issuers. The company issuing a stablecoin can lend the collateral to unknown third parties or even create new coins out of thin air. Basically, investors who don't trust banks end up giving their money to organizations who are even less transparent than a bank.
By contrast, decentralized stablecoins don't belong to any issuer. No entity has control over the collateral. Any user with a minimal technical expertise can review the smart contract and check if the collateral is all there. Moreover, decentralized stablecoins' ROI can even exceed that of interest accounts in regular stablecoins.
Investors are only now beginning to realize the advantages of decentralized stablecoins. However, just one more scandal like the one that happened around Tether will be enough for the public to understand: when you place your money in centralized stablecoins instead of a bank, you swap one non-transparent entity for another.
As the global recession gets deeper, we're likely to get more worrying signs, and investors' faith in centralized coins will wane. It will become clear that the only reliable protection for one's assets is decentralization.