The downside of cryptocurrencies is their volatility. What if there were cryptos with a stable price? This is already the case with stablecoins. Operating via a blockchain, they stand out from other cryptocurrencies because of the stability of their price in relation to the asset they are backed by. In this first guide find out what a stablecoin is and how it works.
What is a stablecoin?
A stable coin is a cryptocurrency that is collateralized with an asset to reflect the price of the asset on the blockchain. A stablecoin can be backed by a fiat currency (fiat money such as the U.S. dollar or the euro), for example, but also by other assets, such as an exchange-traded commodity like gold, or even a cryptocurrency. The ratio remains fixed. To better understand, if you have 1 stablecoin backed by 1 euro, your stablecoin will always be worth 1 euro. This is called 1:1 parity.
Can a cryptocurrency with low volatility be successful? Without a doubt, yes! The stablecoin market is particularly dynamic. Did you know that 2 out of the top 5 cryptos in the top Market Cap are stablecoins? Indeed, Tether and its $USDT token (indexed to the USD) comes in 3rd place, while USD Coin and its $USDC token takes the 5th place. Tether the first stable crypto to be launched, and this, in 2014. Now there are dozens and dozens of stablecoin projects, which can be of several types.
How does a stablecoin work?
A collateralized stablecoin indicates that the company that originated it has – theoretically, as we shall see – the same liquidity as the value issued in token. This means that for a stable coin indexed to the USD with a 1:1 ratio, for each token issued, there must be 1 USD in reserve. This is how the price can be balanced.
A collateralized stablecoin, for example with the US dollar, works as follows:
- If you buy $1 of stablecoin, it will be minted
- If you sell $1 of stablecoin, it will be destroyed
Note that there are also non-collateralized stablecoins, which are defined as seigniorage type, which involve algorithms to manage the volume of tokens according to supply and demand.
What about security? When you think of stability, it seems perfectly safe. Although a stable crypto is not subject to the ups and downs of the market, variations have been noted during strong price shifts in general, including Bitcoin. Moreover, even if it has low volatility, a stablecoin is still subject to the seriousness of the organization that manages it. This is how Tether found itself, among other things, pinned on its insufficient supply of dollars for its $USDT tokens. For this fact,
Tether was ordered in October 2021 to pay $41 million to the Commodity Futures Trading Commission (CFTC). Before investing, as always in the cutthroat world of cryptos, remember to check the project and its history carefully!
Why buy stablecoins?
While cryptocurrency exchange platforms allow buying and selling using fiat currencies, many exchanges do not offer this possibility. Let’s say you want to buy a crypto whose token is only for sale on a DEX that doesn’t accept fiat currencies, and which has a pair with a stablecoin. Rather than buying Bitcoin on a platform and sending it to the DEX in question and paying high transaction fees, it will be much cheaper to turn your fiat currency into stablecoin.
For those who are attracted to DeFi, you should know that it is possible to practice yield farming with a stablecoin, so as to earn passive income. In addition to offering you a whole universe of crypto-currencies, stablecoins also have another great advantage, at least in France: their taxation! We explain it in the next point!
Taxation of cryptocurrencies with stablecoins in 2022
What is the tax treatment of a stablecoin? As you know, you have to declare your crypto capital gains when you file your tax return. The taxation of cryptos in France, at least at the beginning of 2022, requires the declaration of profits (as well as losses) made in fiat currency. In other words, when you turn a crypto into a euro, you must declare it. However, when you exchange a crypto into another digital currency, you don’t have to file a tax return.
So the thousand-dollar question is: should you report your cryptocurrency profits if you’re trading for stablecoins? No ! If you have 1 BTC and you sell it for euros, you must report it on your tax return. If you sell it for DAI($DAI) or any other stablecoin, it is still a crypto/crypto exchange, which does not need to be traced back to the tax department.
- A stablecoin is a cryptocurrency with a stable price, as it is backed by an asset with a defined ratio (1:1 for example)
- There are stablecoins indexed on fiat currencies (US dollar, euro…) as well as on various crypto-currencies or assets (raw materials, precious resources…)
- The stablecoin sector is experiencing strong growth, with USDT, USDC and BUSD in the top three.
- Like any cryptocurrency, a stablecoin can lead to a loss of capital.