How Stablecoins Hedge Against Market Volatility

If a crypto company launches a stablecoin pegged to the US dollar, it is expected to maintain a reserve of dollars in its publicly auditable accounts that is equal to the volume of the crypto issued. 

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In a regular transaction, where the exchanges are supported by the banking system, buying and selling of a crypto asset is instant and the price gets locked immediately.

However, in a P2P system, when a seller matches with a buyer and the transaction is initiated, the seller’s crypto asset is locked in an escrow. The buyer transfers the amount to the seller before getting the asset after due process. The actual transfer could take some time.

It is highly likely that the price of the crypto asset in question changes during that time. If the price depreciates, the buyer will be at a disadvantage, and vice-versa. Stable coins resolve this issue.

A stablecoin is also a cryptocurrency, but its value is pegged to a relatively stable asset, like gold or the US dollar, or other assets easily available globally that do not fluctuate much, unlike cryptocurrencies like Bitcoin or Ethereum that are highly volatile.

If a crypto company launches a stablecoin pegged to the US dollar, it is expected to maintain a reserve of dollars in its publicly auditable accounts that is equal to the volume of the crypto issued. 

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SEE ALSO: 4 Easy Ways on How to Grow Your Crypto Investment

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Examples of popular stablecoins include:

  • USDT
  • USDC
  • DAI
  • UST

To help manage this volatility, stablecoins have been developed. These are tokens that maintain a constant value.

Irrespective of market movements, a stablecoin will always have the same value and this provides traders with an escape to safety when there is market turbulence and uncertainty.

In a P2P transaction, the seller can convert the crypto asset to a stablecoin just before locking the value. 

So if the value is locked at, say $1 000, the buyer will transfer the amount and the value in terms of the stablecoin as well as the float will remain the same for both the buyer and the seller.

This gives the buyer an entry and the seller an exit at a known price point. Later, the buyer can use a stablecoin for crypto-to-crypto deals. 

Another example: 

Let’s say Bitcoin is trading at $60,000. However, due to wild swings, the price jumps up and down several thousand dollars every few hours. To protect their portfolios from this volatility, traders can purchase 60,000 units of a stablecoin to have $60,000 worth of tokens.

Once the markets calm down, he or she can then trade those stablecoins back to bitcoin and still have $60,000 worth of bitcoin. This is advantageous to traders who do not want to risk the potential loss of having their BTC fall below $60,000 even if the price could potentially rise above that level as well.

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RECOMMENDED READING6 Tips on How to Build a Well-Balanced Crypto Portfolio

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