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Understanding Stablecoins And Their Role In DeFi

A stablecoin is one of the first things you need to understand when learning how to invest in DeFi. ...

David Ayegba
6 mins read
A combination of different types of DeFi stablecoins which show an interrelatable property, like stability in crypto prices

A stablecoin is one of the first things you need to understand when learning how to invest in DeFi. This knowledge is crucial when investing in a complex DeFi protocol or simply staking stablecoins.

What is the point of a stablecoin in decentralized finance?

You’re probably just starting out your journey into crypto investing, and after reading this article to the end, you will have learned a lot about stablecoins and how they can be a powerful tool to store value and earn passive income due to their ability to maintain a stable price unlike other crypto prices, as well as to conduct fast transactions at almost no cost.

Now that you know about stablecoin meaning and how it could be useful in crypto investing, let us now talk about the important role it plays in a DeFi protocol. 

The value of a stablecoin is usually tied to either a fiat currency (which are your regular bank notes issued by a country’s central bank, like the US dollar), commodities such as gold, or any financial instruments. What this means is that developers of stablecoins own reserves equal to the amount of stablecoins they have in circulation (the stablecoin market cap). This means that any stablecoin holder should be able to redeem one stablecoin token for one dollar at any time, and vice versa. Blockchain technology enabled stablecoin development.

Most importantly, it provides investors with the opportunity to generate stablecoin yield on their crypto portfolio within decentralized finance (DeFi) protocols through staking stablecoin while avoiding the potential adverse effects of market volatility associated with other cryptocurrencies. This could be a great way to earn passive income for both experienced traders and newcomers to crypto investing. 

What are the types of stablecoins and their uses?

The type of stablecoin is determined by what its value is pegged to; it could be a relatively stable asset like the US dollar or gold. Governments around the world are working towards a clearer regulatory landscape for stablecoins and digital assets alike, which emphasize the need for responsible and transparent stablecoin development practices.

The primary categorization of stablecoins typically revolves around whether they are asset-backed or algorithmic in nature.

  1. Algorithmic stablecoins do not rely on fiat currency or cryptocurrency as collateral. Instead, they maintain price stability through specialized algorithms and smart contracts using blockchain technology, which manage the token supply based on market conditions. When the market price deviates from the pegged value, the algorithm adjusts the token supply to restore stability.

  2. Asset-backed stablecoins are stablecoins pegged to real-world assets, such as fiat currencies or commodities (off-chain assets), as well as other cryptocurrencies (on-chain assets).

  • Fiat currency: These stablecoins are pegged to fiat currencies like the US dollar or the euro. Examples include USDC stablecoin, Binance stablecoin, EURC stablecoin.
  • Cryptocurrency: Some stablecoins are backed by other cryptocurrencies or a basket of cryptocurrencies. Examples include DAI stablecoin.
  • Commodities: These are collateralized using physical assets like precious metals, oil, and real estate. The most popular commodity used is gold, which has led to gold backed stablecoins like Tether Gold (XAUT) and Paxos Gold (PAXG),

It is also crucial not to mistake Central Bank Digital Currencies for stablecoins. A CBDC is a digital form of fiat currency issued by a central bank, existing purely in digital form and typically recorded on a centralized ledger maintained by the central bank. In contrast, stablecoins are recorded on the blockchain.

How to make money from cryptocurrencies using stablecoins?

By learning about stablecoins, you will be able to avoid the mistake most new people in crypto investment make by storing all their digital currencies in volatile assets like bitcoin (BTC) or other altcoins, and help mitigate the risk of loss due to rapid change in crypto prices. Owning stablecoins can allow you to take much-needed time to assess the market and figure out exactly what crypto you would like to invest in without having to worry about losing your money to volatility-induced losses.

Here Are Some Ways You Can Earn with Stablecoins in DeFi:

  1. Staking Stablecoin: In DeFi, staking refers to the process of actively participating in the network by locking up or holding a certain amount of cryptocurrency in a wallet to support the network’s operations. Some stablecoins offer staking rewards for users who hold and stake their coins. By staking stablecoins, you can earn additional tokens as rewards, which can be a valuable addition to you crypto portfolio.
  2. Yield Farming: This is probably one of the most interesting of all DeFi solutions Participating in decentralized finance (DeFi) protocols that offer yield farming opportunities with stablecoins can generate passive income. DeFi protocol is a decentralized application (dApp) for anyone to trade digital assets without a centralized company validating these transactions. To facilitate these trades, a large amount of pools with different asset-pairs are being created which users can use to swap their assets. Anyone can add liquidity to these pools and earn a small liquidity provider fee that is being paid to the users of this particular pool. Decentralized exchanges (DEX) have received a lot of attention from the traditional financial markets as they solve various accessibility problems. 
  3. Arbitrage Trading: Utilizing the price differences between different decentralized crypto exchanges to buy stablecoins at a lower price and sell them at a higher price, thus profiting from the price differentials. Due to the stablecoins stability,  they are rarely used for arbitrage trading as volatile assets provide much better opportunities.
  4. Crypto Savings Accounts: Some platforms offer interest on stablecoin deposits. By depositing stablecoins into these savings accounts, you can generate interest over time. This however comes with risk as giving away the private keys of the stablecoins (which happens by depositing them into centralized exchanges) means exposing them to third-party risk. A centralized exchange (CEX) often uses these funds for untransparent, high-risk investment vehicles. 
  5. Crypto Loans: You can lend your stablecoins to borrowers and earn a stablecoin yield on the amount lent. Platforms offering crypto loans facilitate borrowing and lending between users. Use decentralized and audited platforms for borrowing and lending, as well as for crypto exchanges.
  6. Interest-bearing alternatives: With DERA1 being our flagship solution for yield-seeking stablecoin users, interest-bearing stablecoin alternatives are set to change the DeFi market forever. The reason is simple, DeFi users are constantly on the outlook to maximize their returns. Interest-bearing stablecoin alternatives offer a great solution and create a new income stream for individuals and companies. In the last year alone, multiple products hit the market, trying to resolve this interest problem without compromising the spending power of the currency. Now, in 2024, we can finally release our solution, which offers a way to benefit from the stability of a stablecoin, while yielding the returns of a liquidity pool. As these coins are backed by 24/7 accessible USD stablecoins, they are designed to be used for transactions, in the same way as normal stablecoins.

What will be the next step in the evolution of stablecoins?

Just as traditional fiat currencies existed before the development of stablecoins, it's reasonable to expect further evolution in payment currencies beyond stablecoins. Cryptocurrency and blockchain technology are constantly evolving, with ongoing innovations and advancements shaping the future of payments and decentralized finance.

While stablecoins have addressed some of the limitations of traditional cryptocurrencies by providing stability and reliability, there is still a lot of room for improvement to further develop features around digital currencies. 

We already see continued innovation and evolution of payment currencies beyond stablecoins, driven by technological progress, market demand, and the evolving needs of users and businesses in the digital economy.

Stablecoin facts and conclusion:

In conclusion, understanding stablecoins and their role in decentralized finance (DeFi) is essential for anyone venturing into crypto investment. Stablecoins offer a stable and reliable alternative to traditional cryptocurrencies, providing a valuable tool for investors to navigate the volatile crypto markets and participate in DeFi protocols.

This article has covered everything you need to know about stablecoin meaning as well as the stablecoin yield opportunities in blockchain technology. The importance of stablecoins in DeFi, the different types of stablecoins, and various ways to earn with stablecoins that are not reliant on an increase in crypto prices, including staking, yield farming, arbitrage trading, dollar-cost averaging, etc.

With this knowledge, you can now mitigate the risks associated with market volatility and make informed decisions about your crypto portfolio. Also, always remember that stablecoin can serve as a bridge between traditional fiat currencies and the world of cryptocurrencies, which will offer a smoother transition into the crypto market while minimizing the risks of price fluctuations.

Furthermore, you can now express your opinion about the future of stablecoin development. With the inevitable evolution of payment currencies beyond stablecoins, driven by ongoing innovations and advancements in blockchain technology, even as stablecoins address some of the limitations of traditional cryptocurrencies, further developments and alternate DeFi solutions are likely to emerge. These developments will cater to the evolving needs of users and businesses in the digital economy. As a result, the stablecoin list may expand to include innovative solutions addressing specific market demands, fostering continuous stablecoin development.

So share this valuable information with your network to help others benefit from the opportunities presented by stablecoins in DeFi.

Next up? Learn more about the future of stablecoins

There is no doubt that learning about stablecoins would increase your understanding of DeFi and improve how you interact with DeFi protocols, but taking a step further to learn about the next step in the evolution of stablecoins will help you even more in the future. Our newsroom is filled with articles to help you get started in your search for knowledge to equip you with the right tools for navigating the dynamic landscape of decentralized finance and emerging financial technologies, including blockchain development. There are also other stablecoin news stories that might be of interest to you.

David Ayegba

Content Manager at DERA with 5 years in the crypto space. Passionate about simplifying DeFi concepts to help both newcomers and experienced users navigate the evolving world of decentralized finance.