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Is the Stablecoin Tether An Ideal Hedge Against Crypto Volatility?

By Evan Jones06/28/2023

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Cryptocurrency volatility is both one of its greatest weaknesses and one of its great advantages, at least for traders and those who are able to make the right moves. But for the majority of us, it’s the former, an issue that plagues our portfolios from day to day, and even hour to hour. That’s why stablecoins such as Tether (USDT) are so popular, they can be used as a way to mitigate volatility, lock in profits, and much more.

Before we get into how you can use stablecoins such as USDT to help mitigate volatility, let’s first define them and look into Tether’s history.

What Are Stablecoins?

Stablecoins are digital assets that attempt to offer price stability rather than the inherent volatility experienced by most cryptocurrencies. This is done by pegging the crypto asset’s value to something more stable, such as a fiat currency like the USD.

The stablecoins are then collateralized by having a backing of assets held in reserve. For example, if a company issues $1 million in USD stablecoins then they should also hold $1 million USD in reserve for you to then redeem the stablecoin if you wanted to.

History of Tether (USDT)

The first Tether (USDT) tokens were released in late 2014. At the time the CEO announced that every USDT token was 100% backed by its original currency and could be redeemed at any time with no risk. This statement actually wasn’t true for a period of time, wherein the statement was retracted. This actually made USDT a very risky asset to own, and there was a lot of controversy surrounding the company’s reserves, with the company promising audits but never delivering. Multiple years passed after its release without there ever being a comprehensive audit of the company and its reserves.

However, since the failure of FTX exchange, Tether was essentially forced to provide both a report of their own reserves and have a third-party audit. They passed, and indeed their reserves outnumber their liabilities. This means that Tether can in fact be redeemed at any time by a verified Tether customer and that Tether can cover all their tokens if they were suddenly redeemed. This makes USDT a less risky asset and indeed useful in a variety of ways.

Tether (USDT) Pros & Cons

Pros

  • Stable and fixed value of 1 USD per 1 USDT

  • No value fluctuations

  • Available on multiple blockchain networks

  • Cheap way to send money across borders

Cons

  • Controversial reserves

  • Asset can’t increase in value

  • Inflationary

USDT Use Cases

Now that we’ve discussed the history of USDT along with its pros and cons, we can get into its use cases.

USDT and all stablecoins essentially have the same use cases, so these use cases can be applied to other popular stablecoins such as USD Coin (USDC) and Binance USD (BUSD). 

Hedge Against Volatility

Perhaps the most popular use for stablecoins is to use them to hedge against volatility. Traders can use stablecoins as a way of shorting other digital assets in a bear market. This is essentially done by cashing out profits at a predetermined point, turning it all into stablecoins, and then waiting for the market to drop before buying back in. Because the value of the stablecoin didn’t change, but the value of the volatile asset did, you can buy back more than you had to begin with. 

Similarly, if a trader feels that a bear market or price drop is coming, they can just turn their assets into stablecoins to ensure their value at a minimum locks in where it was. They can buy in again at a lower price assuming the asset does indeed fall in value. This is more so a way to mitigate loss than a way to short digital assets.

Let’s look at a simple example. Say Bitcoin is trading at $40k per coin, but the trader expects it to drop to $35k within X period of time. They can trade that Bitcoin for $40k worth of stablecoins, then when BTC does go down to $35k, they can buy it back but then have another $5k in stablecoins in profit.

They’re also a good way to ensure your profits are stable too. Rather than using profit to buy more digital assets, keeping it as a stablecoin ensures that the profit remains $5k in the above example. If instead of turning the profit into a stablecoin you chose to buy $5k more in BTC then it’s possible that the value of the BTC drops below $5k. These are all risks you have to assess as a profitable trader, which isn’t a bad place to be. 

Cross-Border Payments

Another great use case for stablecoins is for cross-border payments (remittances). If you want to send USD to someone who lives in another country, the fees for sending stablecoins on a blockchain network are exponentially lower than if you were to send a fiat money transfer through Western Union or a bank. The stablecoins are also sent nearly instantaneously. The ability to do this is extremely beneficial for those in countries where it’s difficult to send or receive money without being charged exorbitant amounts in fees and conversions. 

Crypto Sector Payroll

Finally, stablecoins are a popular way to pay people who work in the cryptocurrency sector. If you’re paying developers in the asset they are working with, such as paying an Ethereum developer in ETH, it could lead to dumping of the ETH when they need to pay their bills. For newer projects, this could be devastating to the asset’s value.

Similarly, it could also result in a loss in value overnight due to the volatile nature of non-stablecoin assets. If this occurred at the wrong time it would essentially mean they have been underpaid. By paying people in the sector in stablecoins you can provide stability to both the asset they are helping to develop, and to the employee’s finances.

Closing Thoughts: Digital Dollars for a Digital World

Though stablecoins aren’t exactly an exciting asset to own, seeing as they will never go to the moon as it were, they certainly have an important role to play in the sector.

Using them as a hedge against volatility, to send money to a loved one in another country, or as a way to pay employees anywhere are all great use cases for them. Perhaps their only disadvantage is that they inflate just the same as fiat currency does, meaning that they can certainly lose purchasing power. Regardless, they’re a tool you should consider using if you trade digital assets. 

Article tags

cryptocurrency
guide
stablecoins
Evan Jones

Author

Evan entered the crypto scene in 2017, attracted to the many disruptive possibilities that blockchain could have on current world systems. He has a keen interest in decentralized services, payment processing, and viable NFT use cases such as event ticketing. He spends his days writing with his dog Kobe under his feet, if not on his lap.

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