What are stablecoins and why are they important?

It’s been a volatile few months for cryptocurrency investors. As of this writing, Bitcoin is trying to recover after a steep decline of 30% following the announcement that China plans to crackdown on “bitcoin mining and trading activity”, Ethereum fell 9.3%, and dogecoin fell 4%.

As a result of this volatility, plenty of folks were liquidated. As the weeks have passed, and twitter accounts have bemoaned the unpredictable volatility of the cryptocurrency market, I’ve seen more write-ups about the concept of stablecoins and the role they serve in smoothing out the ups-and downs- of cryptocurrency markets.

Which led me to ask, what are stablecoins and what role do they have in cryptocurrency investment strategy?

What is a stablecoin?

According to Coindesk, a stablecoin is a “type of cryptocurrency whose value is tied to an outside asset, such as the US. Dollar or gold, to stabilize the price.”

Why invest in a stablecoin?

The short answer, according to an excellent post by John Hargrave, is that “stablecoins allow you to hold value without switching back and forth between regular money and digital money.” He uses the below illustration of Bitcoin to illustrate the usefulness of a stablecoin.

Image credit: John Hargrave, LinkedIn

In this example, someone sells one Bitcoin for $50,000 and stores their funds in US Dollar Coin (USDC), a popular stablecoin. In this situation, 1 USDC = 1 Bitcoin. If the price of Bitcoin drops to $35k, you spend $35K in USDC to get one Bitcoin back and have $15k left in USDC.

In essence, stablecoins serve as a “safe haven” or a “store of value” as compared to digital assets. An individual using stablecoins to store value see no risk of loss.

Additional benefits of investing in stablecoins:

• Lower Fees — the high costs of cred card processing fees incurred during transactions can be circumvented through the use of stablecoins
• Borderless — The anonymous nature of cryptocurrencies allows for folks to buy and sell across borders. This is especially critical to folks who live in countries with restrictive export policies or one in which the native fiat currency is drastically losing its value. Stablecoins also provide a store of value that’s strong than Bitcoin because they’re not subject to speculative markets or wild inflation.