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How much of a stablecoin allotment is too much?

Cryptocurrencies are notorious for being volatile assets, which means experienced traders have plenty of opportunities in this space. Investors can expect to be taken on a wild ride if they plan to hold it long.

Stablecoins, a class of cryptocurrencies that offer investors price stability tied to the value of fiat currencies, offer investors a safe haven when market turbulence strikes, but can represent missed opportunities over time.

Speaking to Cointelegraph, several experts have stated that retail investors should approach cryptocurrencies with a “pay yourself first” attitude and that up to a 5% allocation to crypto should be relatively “safe” while allowing for “marginal returns.”

Stablecoins are completely different: no “marginal return” can be expected simply by holding an asset pegged to the value of the US dollar, although returns can reach double-digit annualized percentages (APRs) with decentralized finance (DeFi) protocols. However, these protocols result in a higher risk.

Different stablecoins, different risks

Not all stablecoins are the same. The largest stablecoins on the market – USD Coin (USDC), Tether (USDT) and Binance USD (BUSD) – are backed 1:1 by cash or assets of similar value from centralized entities. This means that for every token in circulation, one dollar is held in cash, cash equivalents or bonds.

For example, other stablecoins like Dai (DAI) and TerraUSD (UST) rely on different mechanisms. DAI is crypto-collateralized and ensures it can maintain its bond by being over-collateralised. It includes economic mechanisms that stimulate supply and demand to push the price to $1.

UST, on the other hand, is an unsecured algorithmic stablecoin. An underlying asset does not support it as it works through algorithmic expansion and supply contraction to maintain its peg. Terra, the blockchain behind UST, has notably built up reserves for the stablecoin. So far, it has already bought almost 40,000 BTC worth over $1.6 billion and over $200 million in Avalanche (AVAX).

Marissa Kim, general partner at Abra Capital Management — the wealth management arm of crypto investment firm Abra — told Cointelegraph that the firm “views USDC and other US-regulated stablecoins as as safe as holding reserves in a bank account,” since these are “required” to be regularly proven that they are fully collateralised.”

For Kim, decentralized stablecoins like DAI and UST could “pose other risks” as volatile markets could cause DAI to lose its peg to the USD. She added that leadership “is provided by the MakerDAO community, and no one knows who holds and governs this protocol and where voting rights might be concentrated.”

Speaking to Cointelegraph, Adam O’Neill, chief marketing officer at cryptocurrency trading platform Bitrue, said that the “role of USDC and USDT” in the cryptocurrency space is “tantamount to the role of the US dollar in the traditional financial ecosystem.”

O’Neill added that investors should use stablecoins “as a hedge when trading and storing their assets.” He added:

“Stablecoin security prospects should not be compared as both the centralized and decentralized versions are inherently secure. However, it is not uncommon for hackers to exploit the vulnerability of protocols designed to offer products that disrupt both classes of stablecoin tokens.”

For O’Neill, how much investors should allocate to stablecoins is a decision and depends on their investment goals. Kent Barton, tokenomics lead at ShapeShift DAO, told Cointelegraph that while each stablecoin has its own risk profile, there are a few things investors should be aware of.

For one, centralized stablecoins like USDC and USDT can be easily converted back to USD, but the entities behind these coins could “potentially blacklist certain addresses, for example in response to claims from legal entities.” Barton added that while there have long been concerns about USDT’s support, it has maintained its peg so far:

“USDT has the advantage of being tried and tested: it is the stablecoin that has been around for the longest time. It has deep liquidity across centralized exchanges and many DeFi platforms.”

Decentralized stablecoins like DAI and USDT, Barton said, are more transparent due to the nature of the blockchains they are built on. However, there are other risks, including volatile markets, that threaten DAI overcollateralization.

For Olexandr Lutskevych, founder and CEO of crypto exchange CEX.io, the security of any stablecoin depends on how security is defined. In terms of the code, technical audits should cover the risks of more vulnerable stablecoins, while in terms of the reliability of moving money from A to B, most are known to do the trick.

Regarding the ability of stablecoins to maintain their peg to the dollar, Lutskevych said how that peg is maintained should be the primary focus of investors.

Stablecoin DeFi Returns: Too Good to Be True?

While merely holding stablecoins ensures that cryptocurrency investors don’t have to contend with the volatility of the market, it also means they don’t see any real returns unless they stake their stablecoins.

There are several options when it comes to stablecoins such as: B. lending on centralized exchanges or decentralized blue-chip financial protocols that result in relatively low returns — often under 5% — that are relatively safe. Switching to riskier protocols or using complex strategies to increase returns could result in higher returns and greater risk.

For example, it is possible to find returns of over 30% for Waves stablecoin Neutrino USD (USDN), which recently broke its peg and fell below $0.80 before starting to recover.

When asked whether investors should lend their stablecoins or add them to the liquidity pools of decentralized exchanges (DEXs) to generate returns, ShapeShift DAO’s Kent Barton pointed out that DeFi protocols bring smart contract risk into the equation that needs to be considered .

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One-month USDN/USDT chart showing when the token broke its peg. Source: TradingView

For Barton, logs that “have been around for more than a few months and have a track record of protecting billions of dollars are pretty safe.” However, there is “no guarantee of future security and stability”. Protocols with higher rewards, he said, tend to be more risky.

Lutskevych suggested that investors should first understand exactly what they are investing their money in:

“Just because it’s DeFi doesn’t change investment principles. And one of the fundamental investment principles is that before proposing a strategy, you should thoroughly understand your risk preferences and individual circumstances.”

For Lutskevych, investors’ capital, time horizon, goals, and risk tolerance should also be weighed when considering staying put or moving stablecoins to generate returns.

For O’Neill, it is “generally advisable that stablecoins should be deployed to take advantage of lending platform returns,” although investors should also be “ready to jump at any investment opportunity.”

Stablecoins offer investors a plethora of opportunities across a variety of blockchains, thanks in part to the DeFi space. Using them outside of centralized exchanges may require some specific knowledge, without which investors may lose their funds, for example by sending them to the wrong type of address.

Risk tolerance and sophistication

Speaking to Cointelegraph, Carlos Gonzalez Campo, research analyst at investment products issuer 21Shares, said that stablecoins offer investors access to a “global network of value transfer, much like the internet has created a global and open network for information.”

Campos said February consumer price index (CPI) data in the United States showed a 7.9% year-on-year increase, meaning people are losing purchasing power at a rate not seen in four decades Has.

What investors do with their stablecoins depends on their risk aversion and sophistication, according to the analyst, as the “user experience is still lacking today” in DeFi platforms that allow users to earn passively from their holdings. Campos added:

“The clearest example is seed phrases that are impractical and unlikely to achieve mass adoption. Because of this, industry leaders like Vitalik Buterin have stressed the need for widespread adoption of social recovery wallets that rely on Guardians rather than seed phrases.”

Marissa Kim of Abra Capital Management appeared to echo Campos’ thoughts when she said bugs and other exploits are possible in DeFi protocols, which often pay higher returns in the protocol’s native tokens. They are “often very volatile and may not be very liquid”.

For Marissa, some investors may be willing to take the extra risk, while others “will be more concerned about capital preservation.”

Regardless of which strategy investors choose, it is clear that stablecoins are an important part of the cryptocurrency ecosystem. Risk-averse investors may find that they only trust the most transparent centralized stablecoins that offer limited opportunities, while more risk-averse investors may prefer higher returns and higher risk.

Over time, the influence of stablecoins in the cryptocurrency space will continue to grow, so it is important that investors understand what they are dealing with and the risks associated with the stablecoins they choose to HODL and what they are trading with do to them.

The views and opinions expressed herein do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should do your own research when making a decision.