Stablecoin vs fiat currencies

We’ll discuss all of these topics in today’s article

stablecoin fiat

Stablecoin vs fiat currencies. Source: shutterstock.com

If you’re looking for some stability in the tumultuous financial world, both fiat currencies and stablecoins can provide that. They have many similarities but many differences too. What type of currency is better for your long-term savings and short-term investments? How can you leverage those “stable” assets?

To begin with, let’s explore the principal differences in the ways stablecoins and fiat currencies emerge and function.

Fiat currencies are issued by national governments. They are not asset-backed. Their value depends on the central bank and the country’s authorities. The central bank can regulate the number of banknotes in circulation by printing and withdrawing them from use. If the country ceases to exist as it happened to the USSR a few decades ago, its fiat currency becomes just a piece of useless paper, since there’s no government to support it. Although fiat currencies are universally accepted, they are subject to inflation and may lose their value quite quickly. In the case of inflation, the purchasing power of a currency unit steeply declines. The government often prints too many banknotes to cope with the general price level increase. If inflation comes extremely fast and gets out of control, the fiat currency usually loses value in the foreign currency market. In the worst-case scenario, that currency must be substituted by another alternative asset.

Stablecoins are issued by crypto companies. These digital assets are backed by more traditional financial investment tools. They can be pegged to any fiat currency, foreign exchange-traded commodities, precious or industrial metals. To issue these cryptocurrencies, the companies need to place the equivalent amount of fiat currency such as USD into bank accounts. Some stablecoins use other cryptocurrencies as collateral. Non-collateralised stablecoins utilise an algorithmically governed approach to control the stablecoin supply. Whichever method applies, the value of a stablecoin is maintained at the same level against the peg. There is no inflation to change that. At the same time, stablecoins tied to the value of USD are affected by the greenback inflation levels. Although their price remains the same, the actual worth of 1 USD may alter. Of course, stablecoins and other crypto projects may also fail and lose value if investors, validators, or developers shy away from them. According to Coinopsy, there are over 2100 “dead” crypto-coin projects today.

Stablecoins are not accepted everywhere. The possibility of using them depends on national policies and regulations. Some countries have banned crypto altogether, while others continuously promote its use. When it comes to crypto, though, stablecoins are preferred by regulators, rather than volatile assets like BTC. For instance, the US approved the use of stablecoin cryptocurrency for bank payments. In the latter case, banks can connect to blockchains as validator nodes, and transact stablecoin payments on behalf of their customers. It makes stablecoins more akin to traditional fiat money than ever before.

Usage

When we compare stablecoins and fiat currencies, we need to understand how useful they are as a means of monetary exchange.

With fiat currencies, it all seems clear. You can spend fiat money in the form of cash or load it onto a debit or credit card. Fiat currencies can be used for direct purchases, money transfers, paying bills or taxes, etc. Most of the existing fiat currencies are applicable only for domestic purchases within the native country’s borders. They need to be exchanged into other currencies while spending abroad. The exchange fee usually applies. If the fee isn’t shown straightforwardly, there’s always an exchange rate margin – the percentage difference between the exchange rate at which banks and currency exchange services trade, and the exchange rate offered to consumers. However, some currencies like USD or EUR may also be accepted abroad without exchanging them into a local currency.

When it comes to stablecoins, most people don’t understand how they can put those crypto assets to good use. The first variant of the application is quite obvious – you can trade stablecoins at crypto exchanges. Some exchanges also allow you to lend your altcoins or stablecoins and earn interest. There are both fixed and flexible lending models, as well as P2P crypto lending marketplaces. Stablecoins currently offer the highest interest rates, between 5% and 25% on most exchanges. The opportunities to earn a yield on price-stable assets are numerous, and they will expand as the DeFi market continues to grow.

Stablecoins can be also used for daily purchases at traditional selling points. So far, the direct purchase option is not widely applicable. However, you can quickly convert crypto to fiat with multi-currency wallets. For example, Trust Wallet, one of the most popular multi-asset crypto wallets, gives you the ability to spend your stablecoins by converting them to fiat and cashing out. In 2019, the BitPay wallet app also announced the rollout of stablecoin payments for merchants and consumers around the globe. Some crypto ATMs like Instacoin in Canada support cashing out the most popular stablecoins at selected locations as well.

Right now, we might be on the verge of a new era for stablecoin payments. With the recent letter to banks from the Office of the Comptroller of the Currency, the division of the U.S. Treasury, even legacy banking institutions are encouraged to safely participate in blockchain transactions. The US regulator describes stablecoins as a new kind of payment technology, and believes banks can both serve as a node on a blockchain, and even issue stablecoins themselves. Although that’s not a legal prescription, the letter is an important milestone in acknowledging the trustworthiness of stablecoin payments.

Investments

The next point of interest for asset owners is the profitability of a financial instrument. We all know that most legacy solutions are more expensive than new fintech schemes. Is that true for fiat money and stablecoins too?

Fiat currencies can be invested into stocks, bonds, and other traded assets as well as put into a savings account for a projected income. The interest you get differs greatly depending on the currency itself, the conditions of the investment, the growth of the chosen asset, or bank policies.

Let’s take the USD for illustration. The US national average interest rate for savings is 0.05% annual percentage yield, but many national banks pay only 0.01%. The best high-yield savings accounts pay around 0.50% APY. The average stock market return is about 10% per year if the S&P 500 is considered as the benchmark measure. Meanwhile, the inflation rate for USD in the last decade varies from 0.6% to 5% in times of crisis. Therefore, even in a stable market, your annual earnings may have reduced your purchasing power in a year due to inflation rates. Moreover, throughout history, the US national currency also experienced wild swings up to 20%.

That’s not the case with stablecoins. Their price is asset-backed and it practically doesn’t change. Nevertheless, they need to be exchanged for fiat currencies to be spent outside of the blockchain, so inflation of the peg currency affects their purchasing power as well. As for investment opportunities, as we’ve already mentioned, lending your stablecoin assets to the platforms supporting such services is quite profitable. The APY of 5% – 25% is much higher than high-yield savings accounts pay for storing your fiat money.

Besides the lending options, savings accounts work for stablecoins too. Last month, Coinbase introduced its high-yield savings account tied to USDC. It offers 4% APY on USD Coins – stablecoins that can always be redeemed one-to-one for $1. Binance offers about 2% interest on flexible savings and up to 5% on locked savings for stablecoins such as USDT and BUSD. Nexo allows customers to earn 12% on their stablecoin savings with daily compound interest and zero fees. At the same time, the fintech platform offers the same earnings rate for traditional fiat currencies like USD, EUR, and GBP.

Stablecoins present another money-making opportunity in contrast to the stock market dominated by fiat. It’s called staking. Staking cryptocurrencies is a process that involves buying and holding a certain amount of tokens to become an active validating node for the network. The buyer becomes a part of the network’s security infrastructure and is compensated accordingly. The staking offers on the market for popular stablecoins may range from 2% to 22% APY.

As you can see, stablecoins can become a much more fruitful investment than fiat money. The only obstacle holding people back from using them as a financial instrument is legal uncertainty and national crypto bans adopted in certain countries.

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