Stablecoins have become a popular method for hedging against inflations based on their ability to provide a moderate measure of security for assets, amidst the highly volatile crypto market. The fact that virtually all the stablecoins are pegged to the US dollar have given many investors more reasons to employ them in hedging against inflation.
Often, what most traders do is convert their indigenous currency into any of the stablecoins to preserve the value of their capital whenever they are bedeviled by the rising inflation in their region.
However, the fact that there is no law backing the stablecoins to ensure the security of the investors’ capital has made the stablecoins a very risky method for hedging against inflation.
This work has therefore examined the advantages and disadvantages of using stablecoins for hedging against inflation.
Meaning of stablecoins
Stablecoins are a special type of cryptocurrency that has been designed to maintain their value over time, regardless of the volatility of other cryptocurrencies. Often they serve as the investor’s safe haven for preserving the value of his assets whenever he chooses to refrain from trading. The stablecoins provide stability to the crypto markets, enabling users to buy them in the hope of preserving their values over time.
What is inflation?
Inflation is a continuous increase in the general price of goods and services available in a country over time. This is usually a result of having large amounts of the country’s currency in circulation and within the hands of consumers. Whenever the price level rises, the buying power of the country’s currency is reduced in return.
Understanding the concept of hedging
Hedging is a strategy used by investors to protect themselves from unwanted price movements. For instance, a crypto trader may decide to Buy Binance (BNB) with leverage and then take another opposite position on the Binance Coin by placing a pending sell order with the same leverage; should the price go against his initial buy positions.
Often hedging can be more extensive, where an investor who had invested in crypto or stocks, might decide to take another position in derivatives and options, or any other security to reduce his risk exposure should there be a crash in the crypto or stock market.
Can stablecoins be used to hedge against inflation?
The de-pegging of the popular stablecoin known as TerraUSD which lost more than 94% of its value in July 2022 has proved that stablecoins are very risky means for hedging against inflation.
While the stablecoins have been designed to provide an escape from the market volatility and for preserving value over time, the revelation from the de-pegging of the aforementioned stablecoin has taught investors that there is no guarantee that any stablecoin will remain stable over time amidst the high market volatility. Since they are not backed by law, it becomes very difficult for investors to claim back their capital should any of the stablecoins depeg in the future.
Based on this risk involved in using the stablecoins for hedging against inflations, many countries today now prohibit the use of stablecoins in their countries.
Advantages of using the stablecoins to hedge against inflations
- Provides an escape from rapid market volatility.
- Helps in preserving the value of one’s capital over time.
Disadvantages of using the stablecoins to hedge against inflations
- Subject to depegging.
- There is no law protecting the investor’s capital against crash.
Most popular stablecoins you need to know today
- Tether (USDT)
- Binance USD (BUSD)
- USD Coin (USDC)
- True USD (TUSD)
- Paxos Standard (PAX)
- Origin Dollar (OUSD)
- Gemini Dollar (GUSD)
- Liquidity USD (LUSD)
- Cello Dollar (CUSD)
- Frax (FRAX)