Why Stablecoins Are Dangerous Crypto Investments When Markets Get Volatile

Posted: Apr 01, 2020 11:25 AM
Why Stablecoins Are Dangerous Crypto Investments When Markets Get Volatile

Source: AP Photo/Lee Jin-man

For years, I’ve heard economists recommend that people invest in cryptocurrency as a “safe haven” option for turbulent financial times. To be fair, they’ve been mostly proven right, since crypto investments do have a tendency to rise when the economy slows and people grow fearful about their financial safety.

For example, 2019’s crisis in Venezuela led Venezuelans to invest in bitcoin instead of Bolivars, which were essentially worthless due to rampant hyperinflation. In Iran we saw a similar rush of popularity for bitcoin during the uncertainty after the assassination of Qassem Soleimani. 

As I also predicted, rising distrust of central banks and governments across the US and Europe led more people to cryptocurrency, which is not controlled by any central or national body.

In our current era of pandemic, with COVID-19 affecting the health of both the global population and the global economy, times are extremely turbulent. Many economists expected to see an equivalent rush for crypto, this time on an international scale, but they haven’t quite seen the results they predicted. And I’m not surprised.

Granted, the cryptocurrency market has remained healthier than stock markets and investments in stablecoins, in particular, have risen in the last few weeks. But I haven’t seen that massive jump in bitcoin on a global level that would mirror the way that it rises during uncertainty on a local level. 

It seems that investors instinctively realized that during a global financial crisis, you can’t rely on bitcoin. In the words of Don Caplinger of The Motley Fool, bitcoin has failed the coronavirus test. “For a long time, cryptocurrency advocates have argued that tokens are ideal safe havens from the uncertainties of the broader financial markets,” he wrote, but given the situation today, “cryptocurrencies had essentially lost their safe-haven status and were once again perceived as a risky asset.” 

In my opinion, diversifying is the only reasonable response to economic havoc.

Diversifying Is Key

One of the founding principles of investing is that in times of trouble, you hedge your bets, quite literally. I see it all the time; when the markets tumble, people move their investments from stocks into oil. The price of gold rises, because it’s perceived as a stable way to store value. 

Uncertainty means that you spread your risk, and these are definitely uncertain times. There was a smell of recession in the air after a series of destabilizing events in 2019, even though the threat had receded and things seemed to be calming down in the opening days of 2020. 

It’s a good time to diversify your portfolio, but pouring all your money into cryptocurrency doesn’t necessarily bring you closer to diversification. 

Stablecoins Are Not a Silver Bullet

Which brings me to the misperception of stablecoins. Stablecoins were developed to give investors a way to store value without it fluctuating along with unstable markets. They were intended to be a more stable (hence the name) alternative to volatile bitcoin and similar cryptocurrencies, and they partially succeeded. 

Stablecoins are more stable than other cryptocurrencies, as reflected by the fact that they are performing better than non-correlating crypto, but it’s all relative. 

As Elias Simos, an associate at Decentral Park, put it, “Stablecoins are not stable, and don’t look like they are getting to it.”

That’s because of the fundamental flaw in the design of stablecoins: pegging them to a single fiat currency, or to commodities like oil. When your crypto is pegged to a measure that’s fluctuating wildly itself, you can’t pretend that the crypto is stable. 

I think it’s ironic, really. Stablecoins were intended to free the holder from the fluctuations of the global currency and commodity markets, but by pegging themselves to a single fiat currency or commodity, they’ve replicated the same problem in the cryptoverse. 

What’s more, as I already mentioned, many people who invest in crypto do so precisely because they want to escape the control of central banks. Central banks are seen as making economic decisions that primarily serve their own agendas. It’s usually necessary for them to place local economic and political interests above the interests of the global economy. 

But stablecoins that depend on individual currencies or commodities still rely on the decisions of these same central banks, which means that you’re really still dependent on them. You just have the illusion of being free. 

As a result, all those people who are currently investing in stablecoins are wildly mistaken. It’s true that the most popular stablecoins, like Tether, USDC, and Pax, are linked to the US dollar, which has been stable thus far. However, as the number of Covid-19 cases rise in the US, there’s no way to predict whether or not that will continue. The same is true of the euro, another major currency that is currently facing enormous destabilizing problems. I think we could yet see the USD fall against the euro. 

I have to agree with Ido Sadeh Man, who said in a recent interview that “If you think pumping your assets into stablecoins means that they are better protected than if they were held in a single currency bank account, you are running from one burning house into another. It’s the same fire.” 

You can even see the proof in the fact that although leading stablecoins like Tether and USDC rose by capitalization recently, they still fell by volume. To put it simply, more people invested in stablecoins, raising their market share, but at the same time the market to which they are pegged dropped, lowering their value. 

Learning from a Pre-diversified Currency Index

While it’s always preferable to take a hands-on approach to diversifying investments, there’s a lot we can learn by looking at how the banks do it, with the SDR, or Special Drawing Rights reserve. 

The SDR was created by the International Monetary Fund (IMF) in 1969 as a basket of the world’s five major currencies. Today, it includes the US dollar, the British pound, the euro, the Chinese yuan, and the Japanese yen, although in differing proportions – the dollar and euro collectively hold 73% of the weight.

This is arguably the most stable asset on the market right now – and indeed, almost all the time – because it’s pegged to five currencies, not just one. Even if all five of them fall, the spread means that the SDR will fall less than each individual currency. (And if all five of them tank, then we’ve got bigger problems than our investment portfolios.)

For example, due to the way that Covid-19 has spread gradually across the world, we’re seeing that China and Japan are in a position to begin to rally economically, while the US, the UK and Europe are only just beginning to fall. 

It’s worth noting that only central banks are able to invest directly in the SDR. However, SGA, a crypto token offered by the Saga Foundation, essentially mirrors the SDR. The SGA currency is backed by a variable reserve held in major national currencies in a composition that replicates the SDR.

Diversify to Stabilize

To summarize, turbulent times demand that you hedge your investments. Although cryptocurrency has been seen as a safe haven in times of economic uncertainty, it’s not as stable as it appears, and that includes stablecoins. 

Diversifying your investments is the only way to reduce your exposure to risk.