Portfolio Stabilization: Managing Stablecoins in the Face of Market Turmoil

The Value of Stablecoins

Stablecoins are one of the best tools in any cryptocurrency investor’s handbook when it comes to portfolio management. The value of these cryptocurrencies is pegged to the value of a specific asset – usually a fiat currency such as the U.S. dollar – and are immune to the price fluctuations the crypto market is known for.

Crypto investors see several advantages in stablecoins: They are based on the blockchain, which means they can be transacted at any time, with anyone, for a small fee. Because their value is pegged to the value of a stable asset, they can be used to hedge portfolios and stabilize them during market turmoil.

Is There an Ideal Stablecoin Allocation?

Managing stablecoin allocations can be tricky. If an investor’s entire portfolio is allocated to stablecoins, they may completely miss out on a bull run. If they invest in the wrong stablecoin, they can be worse off than if they were investing in the riskiest of assets, as some stablecoins have lost their peg and collapsed.

Earlier this year, for example, Terra’s ecosystem went into a death spiral that resulted in both its native token LUNA and its algorithmic stablecoin UST becoming nearly worthless.

Speaking to BSC News, Brian Greenberg, the founder of insurance company Insurist, advised a stablecoin allocation of between 30% and 50% of investors’ total cryptocurrency portfolios.

Greenberg said there are “many ways to diversify your portfolio” and that while the most common technique is to buy “as many tokens as possible,” the risks involved are significant. Investors looking to diversify should explore different types of stablecoins, he said:

“For example, [investors] could buy USD-backed tokens, crypto-backed tokens, and gold-backed tokens. This way, they'll have some protection against any fluctuations in the market.”

Yohannes Christian, research analyst at cryptocurrency exchange Bitrue, told BSC News that stablecoin allocations should be flexible, according to factors such as market conditions, portfolio objectives, and investment horizon.

For example, in a bear market, investors should look to acquire the most promising cryptocurrencies at a discount. But if the goal is wealth preservation, portfolios should contain a higher percentage of stablecoins.

Experts seem to agree that crypto investors should hold at least some stablecoins. But which ones should they buy?

Diversifying Stablecoins

There are several types of stablecoins, some managed by centralized entities and others by decentralized entities. Terra’s UST was managed by a blockchain protocol and ultimately collapsed, but that doesn’t mean decentralized stablecoins are bad.

DAI, issued by MakerDAO, has been around for longer than UST and hasn’t lost its peg. DAI’s stability derives from its overcollateralization by cryptocurrency holdings, managed by a protocol.

Stablecoins can be backed by different assets and methods, including:

• Fiat (USDT, BUSD)
• Cryptocurrency (DAI)
• Commodities -- i.e. gold (PAXG, XAUT)
• Algorithmic (UST)

Christian said it was a necessity for investors to diversify their holdings among various stablecoins, with UST proving that such diversification is “essential to minimize non-system risk, even between the same asset classes.” Christian added:

“While U.S. dollar-backed stablecoin is considered one of the most reliable pegging mechanisms, there is always a project-specific risk that investors must consider.”

Per the analyst, factors to consider include system security threats, market volatility, and the potential collapse of the U.S. dollar itself.

Speaking to BSC News, Richard Gardner, CEO of fintech firm Modulus Global, said risks include government regulations. According to Gardner, as central banks develop Central Bank Digital Currencies (CBDCs), they may move to ban private stablecoins, especially taking into account Terra’s collapse.

He said stablecoins are a “high-risk investment” until concerns surrounding a potential ban or crackdown on these digital assets are “sorted out.”

Whichever stablecoins investors may choose, there are ways to use them to earn interest and returns without having to do much. That yield, however, isn’t risk-free.

Is Passive Yield Worth Chasing?

Earlier this year, crypto lenders, including Celsius Network and Voyager Digital, filed for bankruptcy as liquidity tightened, forcing investors to reconsider whether it’s worth lending out their holdings to these platforms to earn interest, even if annual percentage rates exceed inflation.

Similarly, Decentralized Finance (DeFi) platforms offering lending services may suffer a security breach, rug pull investors, or otherwise fail.

However, Bitrue’s Christian told BSC News that the yield is indeed worth going after, saying investors should “try every conceivable way to earn the highest possible return on their investment portfolio.”

He said, “Low risk, low cost, and high flexibility to move between other asset classes are other factors that need to be addressed in the search for investment yield. For example, CeFi [centralized finance] usually offers a lower yield on stablecoins than DeFi.”

Christian added that the risk is often lower on centralized platforms.

Investors looking to earn yield should perform due diligence. A good first step is to check if decentralized projects have been audited and are trusted by the community, as well as checking the track record and general health of centralized exchanges.

Keep in mind that if you aren’t sure where the yield is coming from, it’s likely you are the yield.