7
min read

Stablecoins and How to Use Them to Generate Passive Income

What is a stablecoin? Find out about the different types of stablecoins and why you should invest in them

Stablecoins rose as a viable option for those who wish to invest in crypto without exposing their assets to the risks associated with cryptocurrencies’ notorious volatility. Indeed, compared to regrettably low-interest rates that EU banks usually offer to their customers, investment in stablecoins can yield up to 10 times as much without dragging all crypto-related risks into the game.

Yet, stablecoins are not as successful as Bitcoin in terms of public awareness, so it is likely that some prospective users have hardly heard about them. In this article, we will cover the basics of stablecoins one should know to use and profit from them, and why you should include stablecoins as part of your investment portfolio.

What are stablecoins?

Simply put, a stablecoin is defined as a type of cryptocurrency that is backed by or pegged to another asset in order to make its price steady and completely avoid any fluctuations. Those backing assets can include fiat currencies, currency baskets, commodities, other cryptocurrencies, and virtually anything of value. It is safe to say that stablecoins are a fully digital incarnation of real-life physical assets. Each type of backing corresponds to a specific kind of stablecoin. We’ll discuss those different kinds in greater detail later on in this article.

The most popular stablecoins at the time of writing are as follows:

  • USDT aka Tether, the first stablecoin to be issued and by far the most prominent.
  • EURL (Lugh) developed by Société Générale in cooperation with the notable blockchain company Nomadic Labs, a stablecoin pegged to Euro and specifically designed to fully comply with relevant EU regulations and bylaws.
  • USD Coin (USDC), another USD-backed stablecoin that acts as the direct rival and competitor of USDT.
  • DAI, a mixed breed of stablecoin pegged to USD but backed by Ether, is an early example of algorithmic stablecoins whose supply is governed automatically by smart contracts rather than by a person or even a company.

Stablecoins pegged to gold or other cryptocurrencies are relatively rare. In most cases, the public demand goes for those backed by U.S. dollars at the ratio of 1:1. Thanks to this, USD-backed stablecoins combine the stability of the exchange rate with the practical convenience and high speed of cryptocurrency payments, which is exactly what made those digital coins popular in the first place.

At Cabital, we’ve chosen USDT because the stablecoin is fully backed by an equivalent amount of USD in cash and cash equivalents in reserves. Tether’s consolidated total assets amounted to almost $35.3 billion as of February 2021, while the value of the stablecoins issued stands at $35.1 billion. 

Other notable features of stablecoins include:

  • Usually, stablecoins are subject to specific regulations, such as the EU’s proposed MICA framework (Markets in Crypto-Assets), ensuring full compliance with international monetary laws. This makes stablecoins a great choice for those generally unwilling to risk dealing with cryptocurrency for legal and/or economic reasons.
  • The backing of most stablecoins is subject to independent audit as it is imperative to prove that the backing of those crypto-assets actually exists. This adds another layer of financial security to those who use stablecoins on a regular basis.
  • The stability of a stablecoin’s exchange rate makes it perfectly suitable for mundane transfers and investment as it completely mitigates the risks of price fluctuations overwhelming the payment convenience or profitability.

In terms of investment, stablecoins offer a decent interest rate compared to those usually found in banks dealing with savings accounts. For instance, here at Cabital, we offer 12% APY on USDT compared to 1-1.2% usually offered by banks. This makes stablecoins a great weapon of choice for those wishing to earn more on their savings without risking too much or entering the grey area commonly associated with cryptocurrencies. 

Stablecoin vs Bitcoin

As a cryptocurrency, stablecoins are inevitably compared to Bitcoin, the first currency of this kind. Nonetheless, while they share some technological fundamentals, such as the use of blockchain technology, there are more differences than common features between them. In brief, Bitcoin and stablecoins are different in the following terms:

  1. Their value and economic nature.
  2. Their technological essence.
  3. The presence of backing.
  4. Their legal position in different jurisdictions.
  5. The extent of risks involved.

First of all, Bitcoin is a speculative tool with a higher volatility rate, and its price rises and crashes down like the ocean tide on a stormy day. Unlike stablecoins, Bitcoin works very poorly both as money and as a store of value. Indeed, it’s quite unreasonable to use something with an extremely unsteady price as a means of payment or as a safe haven. Stablecoins, on the other hand, work perfectly as day-to-day money; are similar to fiat in terms of value storage, and can successfully be used for investment without too much of a risk. After all, unlike Bitcoin’s, a stablecoin’s price remains the same by definition.

Secondly, Bitcoin is backed solely by its own supply rate, the complexity of puzzle-solving required for its mining, and the extent of faith crypto-traders have in it. On the other hand, stablecoins are not mined but released to represent the units of an existing asset on the blockchain, and those assets are actually audited and accounted for. 

Stablecoins usually require independent auditors and fully compliant bank accounts. Therefore, they are well within the legal framework of the developed world, especially in the U.S. and the European Union. Nonetheless, Bitcoin is downright banned in some jurisdictions, seriously frowned upon in others, and usually involves troubles with bank accounts and barrages of questions from tax authorities. 

It all basically means that Bitcoin is much riskier when compared to stablecoins. The losses one may incur due to Bitcoin trading can be enormous, but so can profits. Stablecoins, on the other hand, offer a more reasonable alternative where risks are comparable to those present in a regular bank handling your savings account while profits are much higher.

That is not to say, of course, that stablecoins are completely risk-free. Their risks mostly have to do with those faced by banks or certified auditors as the availability of the backing directly depends on their continuous operation.

Table 1. Comparison of practical aspects of Bitcoin and stablecoins

In the end, preferring Bitcoin or stablecoins comes down to its intended use, so it would be unreasonable to say that one is fundamentally better than the other. Thus, if your goal is to make profits from risky trading, Bitcoin is obviously more suitable for such purposes due to its high volatility and popularity. Still, if your goal is to profit in the mid to long term, investing in your stablecoins seems like a more viable option due to their low volatility. 

Are stablecoins securities?

This is the question that might pop up for everyone remembering how the ICO craze of 2017 was cut short by the decision of the U.S. regulator, the Securities Exchange Commission, to apply the securities bylaws to tokens issued by projects to raise funds. The American regulator’s opinion is usually taken for an example by securities authorities in other countries, most notably European Securities and Markets Authority (ESMA), so it often comes down to their judgement.

So, are stablecoins actually securities? To answer this question, it is worth remembering the so-called Howey Test used by the SEC. Basically, it says that whatever you are dealing with is indeed security and has to be treated as such if it meets all four requirements listed below:

  1. It is an investment of money.
  2. The investment was made to a common enterprise.
  3. The investment was made with the expectation of profit.
  4. The profit was expected solely from someone else’s effort.

Legally speaking, this divides all stablecoins into two distinct groups. In practical terms, regulators usually consider items 1 and 3 through 4 met by default when it comes to stablecoins. What really matters, therefore, is whether you are dealing with a common enterprise. So, for the stablecoin to be viewed as a security, the money you spend buying stablecoins must go to the common pool of funds set by the issuer and used for profit-making.

The table below can be used as a brief guideline to determine whether the stablecoin in question is a security.

Table 2. A brief description of what makes stablecoin a security

That said, to be sure you are on the safe side, you should seek professional legal counselling or work with a company like Cabital that ensures full legal compliance for its customers.

Types of stablecoins

As mentioned above, stablecoins are primarily different in what is used as their backing. The type of asset underpinning a given stablecoin determines not just its relative price but also its intended use. Below we listed the most widespread kinds of stablecoins as well as their most fundamental features.

Fiat-collateralized Stablecoins

  • Uses a fiat currency or, more rarely, a basket of fiat currencies (most likely the most stable ones like USD, EUR, JPY, SWF, and GBP) as collateral
  • The most popular type of stablecoins
  • Good for day-to-day payment or making an investment
  • Regulated and audited
  • Typical specimen: Tether (USDT)

Commodity-collateralized Stablecoins

  • Most likely uses a precious metal like gold or silver as collateral
  • Offers full backing but redemption is usually complex and takes several phases as it covers working with actual gold and certificates
  • Regulated and audited
  • Price follows the price of the chosen commodity
  • Popular among some long-term investors
  • Typical specimen: Digix Gold Token (DGX)

Crypto-collateralized Stablecoins

  • Uses other cryptocurrencies as collateral
  • Fully decentralized
  • Usually unregulated, auditing is not mandatory 
  • Good for speculations, often used at decentralized exchanges as a replacement for fiat
  • Moderately popular mostly among daily traders
  • Typical specimen: DAI

Non-collateralized Stablecoins

  • Not backed by any actual asset but governed algorithmically (hence the alternative moniker, algo-stablecoins)
  • Supply and demand are automatically regulated in such a way as to keep the price at the same level
  • Unregulated, auditing is not mandatory
  • In need of continuous growth of capitalization to remain stable
  • The least popular kind of stablecoins, sometimes regarded as non-stablecoins
  • Typical specimen: Ampleforth

How to make money with stablecoins

Similar to the assets they represent, stablecoins can be used to make an investment of some form. The properties of such an investment closely mimic the conditions you would have faced had you decided to use the non-digitized form of said assets. That being said, there are three fundamental ways of profiting from stablecoins.

Earn interest on stablecoins

In this case, you have a third party, like Cabital, to work with your stablecoins. Simply put, you deposit the desired amount of stablecoins, which the company then uses to make secured loans to other parties. At the end of the agreed period, you get your money back plus the interest accrued over time, which can be as high as 12% a year. This allows you to enjoy passive income while spreading the lending risks. This works well with fiat and commodity-collateralized stablecoins. Cabital works with USDT as it is fully audited and compliant with stablecoin regulations in key jurisdictions.

Lending stablecoins on your own

This option is quite similar to the previous one except you handle crypto lending on your own, and therefore, bear all the risks yourself. On a platform like Compound, you can borrow and lend cryptocurrency on a short term basis, moving your assets around liquidity pools in a constant chase for the one currently offering the highest annual percentage yield (APY). In order to fully enjoy this method, you have to duly research all lending outlets present on the market, assess the risks, sometimes handle the paperwork etc. Knowing all the nuts and bolts of the industry is a must here, otherwise, risks get way higher, and compared to the method above they are elevated by default. 

Staking stablecoins

If you lock your stablecoins to ensure the proper operation of the entire network they circulate on, the network will pay you rewards for doing so. This process is called staking and is quite common in systems using the Proof-of-Stake algorithm. A user puts their money in a special wallet, node, or platform and does not access it. In exchange, they get a stake in the system in the form of network voting rights, mining rewards, or other perks as the case may be. Similar to making a bank deposit in more than one way, this method returns a small but surefire interest. This method suits those interested in the technological advancement of the cryptocurrency in question as the economic stimulus might be negligible.

Profit from Stablecoins with Cabital

Similar to other players in the field, Cabital offers to earn interest on stablecoin loans. But unlike its competitors, we set no entry threshold for our customers to unlock the highest interest rate, nor do we expose them to the risk of staking platform tokens in order to gain higher yield. Holding native tokens places users at the mercy of drastic value fluctuations, which won’t be made up by the yield generated. Other security concerns include ICO frauds and scams, and the possibility of token theft.

The advantages of working with Cabital go further to include:

  1. Short-term test deposits enabling everyone to make sure everything works fine without risking too much.
  2. Full legal compliance with European regulations as well as official registration in the EU (reg.no. 305748659) ensuring smooth and trouble-free profiting.
  3. The annual yield of up to 12% on any deposited/staked amount.
  4. SEPA transfers for instant remittances. (Coming soon!)

For more detail, please read our product description.

Afterword

All in all, dealing with stablecoins is one of the best ways for an investor with a moderate risk appetite to profit from cryptocurrencies. They offer a wide range of collateralization options fitting different investment tastes and generally represent a decent way to hedge against the risks normally inherent in crypto. While not entirely risk-free, they offer more financial reliability and legal safety than any other kind of crypto asset.

This article has been prepared by Cabital Fintech (LT) UAB  (the “Company”) and is general background information about some of the Company’s activities at the date of this presentation.

This article does not contain all the information that is or may be material to you and should not be considered as advice or a recommendation to you in respect of the holding, purchasing or selling of digital assets and does not take into account your particular objectives, financial situation or needs. This article has been made to you solely for information purposes. This presentation may be amended and supplemented as the Company sees fit, may not be relied upon for the purpose of entering into any transaction and should not be construed as, nor be relied on in connection with, any offer or invitation to purchase or subscribe for, underwrite or otherwise acquire, hold or dispose of any digital assets, and shall not be regarded as a recommendation in relation to any such transaction whatsoever. The contents of this presentation should not be considered to be legal, tax, investment or other advice, and you  should consult with your own counsel and advisers as to all legal, tax, regulatory, financial and related matters concerning an investment in or a disposal of such digital assets and as to their suitability for you.

This presentation and its contents are proprietary to the Company, and no part of it or its subject matter may be reproduced, redistributed, passed on, or the contents otherwise divulged, directly or indirectly, to any other person (excluding the relevant person’s professional advisers) or published in whole or in part for any purpose without the prior written consent of the Company.

This article contains forward‐looking statements. Such forward‐looking statements involve known and unknown risks, uncertainties and other important factors. Certain forward‐looking statements are based on assumptions or future events which may not prove to be accurate, and no reliance whatsoever should be placed on any forward-looking statements in this article.

The information in this article has not been independently verified. No representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the presentation and the information contained herein and no reliance should be placed on it. Information in this article (including market data and statistical information) has been obtained from various sources (including third party sources) and the Company does not guarantee the accuracy or completeness of such information.