Solving the Traditional Fixed Income Problem with Stablecoins

What are Stablecoins?

Stablecoins are a specific type of cryptocurrency that, like their name says, stay stable when the market fluctuates. The purpose is to bridge the gap between traditional currency like the US Dollar (USD) and Cryptocurrency. Price stability is built right into the code of the cryptocurrency. This allows the coin to behave more like a fiat type of currency. This appeals to many investors who invest in traditional credit markets and the digital asset market. There are four different types of stablecoins, fiat-backed, crypto-backed, commodity-backed, and algorithmic.

The idea of stablecoins was first thought of because of the cryptocurrency market’s volatility. Digital asset creators are constantly trying to find ways to reduce risk and increase participation in the cryptosystem as a whole. 

Fiat-backed Stablecoins

Fiat-backed stablecoins are the most popular; they are backed by 1:1 to fiat currency like the USD. This type of stable coin is considered an off-chain asset because the underlying collateral is not a digital asset. Some of the more popular stablecoins of this type are Tether (USDT), Gemini Dollar (GUSD), and USD Coin (USDC).

Crypto-backed Stablecoins

Implied in the name similar to the first type of stablecoin, this type of stablecoin is backed by a different cryptocurrency as collateral. Thus, these stablecoins are considered on-chain. These stablecoins use smart contracts to lock your cryptocurrency and obtain tokens of equal representative value. DAI is the most popular stablecoin that is crypto-backed. Most crypto-backed stablecoins are over-collateralized to buffer against the price fluctuations.

Commodity-backed Stablecoins

Physical, real-world assets back these stable coins. These assets can be anything from metals and oils to pieces of real estate. This was made so that people who would usually not be able to invest in the value of these physical assets have the opportunity to do so. The most popular commodity-backed stable coins are collateralized by gold; Tether Gold (XAUT) and Paxos Gold (PAXG).

Algorithmic Stablecoins

As the name implies, algorithmic stablecoins use an algorithm and smart contracts instead of using fiat or cryptocurrency to determine the price. These specialized algorithms manage the supply of tokens in circulation. They will reduce the amount in circulation depending on if the market price falls below the cost of the fiat currency that it stays in line with. The opposite is true if the digital asset exceeds the cost of the fiat currency.

Why invest in Stablecoins?

In today’s traditional fixed income world, your typical basket of cash, bonds, CDs, and municipal bonds yields on average <2% year over year. This means that the traditional asset allocation, which has 40% in fixed income under the assumption of a 5%+ yield to meet planning goals, is truly yielding 3%+ less than planning assumptions. If you apply the actual rates of return and consider real inflation, 40% of an investor’s portfolio is now losing you money year over year (currently around -5% YOY return). This is the most significant asset allocation and retirement investment problem today. People’s “safe” money is now losing money faster than ever before.

What does this mean for our future?

Investors cannot save, invest or retire on the traditional asset allocation model. Traditional fixed income is broker and new solutions are needed in its place. Stablecoins offer an alternative and can act as part of the solution. As an example for our clients, we manage a basket of coins for our clients for them, which currently yield 6%+ on average[1]. So if someone’s traditional fixed income portfolio is generating -5% now, with a change in strategy, they can change their strategy and achieve potential 10%+ higher returns on their “safe” money. This is all done by working with the right professionals and looking at new solutions to financial problems today. 

[1] Based on Stablecoin yields as of April 6, 2022