Stablecoins: Unlocking the Power of Cryptocurrency Stability

As we already know, stablecoins represent a clever way to realize profits trapped in the revaluation of a token without the need to transfer profits to a traditional FIAT based bank account.

Nowadays, stablecoins are a big player in the cryptocurrency world; for example, Theter (USDT), the first stablecoin, after bitcoin, is the third most important player in the cryptocurrency field, with around $82 billion market cap in a game that is worth 1.1 trillion USD.

Regardless of the great importance that stablecoins also have in the Defi ecosystem and the great value that this has, specifically in the race for inclusion to the financial system of many excluded people form the traditional financial system around the world, stablecoins have evolved and became more complex every day, so it is important to fully understand what is going on, at least, in a general way behind such assets.

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Fiat currency-backed stablecoins

In this case, you deposit FIAT currency, for example, US dollars, and a stablecoin is issued. To me, this is nothing more than the token representation of FIAT money and no barter transaction should be considered for tax purposes (so a tax treatment similar to what was concluded by the European Court through the famous Skatteverket v David Hedqvist case should apply). It is as simple as that. It is not the FIAT money per-sé, but it is its representation.

When you want your FIAT money back, what you do is send the token to the Smart contract and the token that you “send back” to the Smart contract is burned. That way, there will always be one to one, in the case of the example, one dollar, one token.

Stablecoins backed by digital assets

It is a case that works a bit similar to the previous case, but with the variant that, for the Smart contract to release a stablecoin, you must deposit in a vault, cryptocurrency or tokens, which, in value, will exceed the amount of the stablecoin that the protocol is issuing. In other words, you are pledging cryptoassets for a greater value than the stablecoin they are issuing you.

Then, I can use that stablecoin to generate profits on some project that requires liquidity and that I hope will pay me something worth having deposited the cryptoassets in the vault. I do this when I am hopeful that the cryptoassets I deposited are going to go up in value in the future and I will earn that plus the return that the protocol I invested that stablecoin in gave me.

But if the collateral or guarantee that I leave, turns out to fall in value abruptly, as has happened the market on several occasions, then the Smart contract, automatically, executes the guarantee, that is, sells the assets that I deposited in collateral and I am left with the stablecoin that was issued to me. Bad bet.

In any case, a barter transaction is carried out and tax effects should be recognized as such, depending on the country in which you reside and with the particular rules applicable.

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Algorithmic stablecoins

This is the most complex form of stablecoins and the short history of crypto has taught us to be cautious with this type of protocol. There we have the terra-luna case, for example, where trust in the protocol was lost also wealth.

And I would like to make a small allusion to how central banks work in general and then land that concept here.

To control inflation, central banks usually apply a restrictive fiscal policy that consists of the bank issuing prizes (interest) so that people find it attractive to put their money there. When people see that it is more convenient to put their money in the bank than to invest in some risky project that will give me a rate similar to the one given by government bonds, for example, they prefer not to take the risk and buy government bonds that pay well and typically do not carry a high risk.

And, on the other hand, people stop borrowing so much because the interest rate is very high. So, there is less money in the market. Thus, inflation goes down because there are fewer USD.

The smart contracts that trade the stable currencies in this category, they operate a little bit similar. That is why I wanted to explain this first.

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In short, the algorithm or programming of the smart contract seeks to ensure that when there is a positive inflation in the value of the stablecoin, and we are talking about tenths or hundredths of cents with respect to the dollar, for example, then it is necessary to collect stable currencies from the market and, for this purpose, a kind of discount bond or rights are issued to buy stable currency at a discount, but not immediately, but when the inflation of stable currency has gone down. If it could be cashed in immediately, there would be even more stable currencies and it would not solve the problem, it would make it worse.

On the other hand, if there is negative inflation or deflation of the stable currency, that is, the value is less than 1 dollar, then those who bought the right, will be able to exchange their stable currency which they bought at a discount and which is worth 1 dollar. Income is there for tax purposes. As there are more stable currencies in the market, there will be a micro inflation and we can say that the price of the stable currency would be adjusted to 1 again.

In other words, in the event of any change in the value of the price of the stable currency, the mechanism or programming of the smart contract manages to control the inflation or deflation of the same.