One of the easiest ways to earn returns from cryptocurrencies and, at the same time, reduce the high price volatility associated with crypto assets is to stake stablecoins.
In this article, you will learn all that you need to know about staking stablecoins, including the risks and benefits.
What is a Stablecoin?
A stablecoin is a digital currency whose value is tied to the value of another asset, such as a commodity, fiat currency or another cryptocurrency.
How do stablecoins stay stable? The idea behind the design of stablecoins is to provide a cryptocurrency that is, to a considerable extent, void of price fluctuations by tying its value to a more stable asset. Thus, a stable price is maintained.
Several stablecoins are preferably pegged to fiat currencies. Based on the assets to which these coins are tied, there are four main types of stablecoins.
Fiat-backed stablecoins are pegged to the value of fiat currencies, such as the U.S. dollar or Euro. A stablecoin tied to the U.S. dollar is structured to maintain the value of one dollar.
Examples include Tether (USDT) and USD Coin (USDC).
Crypto-backed stablecoins are pegged to other cryptocurrencies like Ether (ETH). An example is DAI.
These stablecoins are tied to the value of physical assets such as high value metals (like gold) and real estate. An example is Digix Gold Token (DGX), which is pegged to gold.
Algorithmic stablecoins, as the name implies, are stablecoins that are governed by algorithms (that is, smart contracts). An example is the collapsed TerraUSD (UST).
Shi stablecoin, which will be released in 2022 at an unconfirmed date, is said to have been designed in an improved way; better thanTerraUSD before its collapse.
What is Stablecoin Staking?
Staking cryptocurrencies allow users to earn rewards by depositing their crypto assets in a blockchain network and holding them for a period of time. This form of cryptocurrency staking is also used to support validators in the Proof-of-Stake mechanism.
Stablecoin staking, though, is quite different from cryptocurrency staking explained here.
Technically, stablecoins are ‘staked’ when they are lent out for a period of time in order to earn rewards. Users can buy stablecoins, deposit them on lending platforms and earn interest. The more stablecoins they stake, the more interest they earn.
Due to the nature of several stablecoins which are pegged to stable assets, stablecoin staking is not subject to the risk of significant changes in value unlike other cryptocurrencies.
While considering which stablecoin to stake, it is also very important to carefully consider the platform to stake on. With many platforms available, there is a need to make sure that the platform you choose is safe and reliable.
A prominent example of a platform where stablecoins can be staked is Binance, a cryptocurrency exchange where a user can lock USDC and USDT for a flexible period of time to earn yields.
Risks Associated with Stablecoin Staking
As with cryptocurrency staking, there are risks associated with staking stablecoins.
- Although stablecoins are generally more immune to drastic changes in value than other cryptocurrencies, the asset to which the value of the stablecoin of choice is tied should be carefully considered. This is because when the value of the pegged asset drops, the interest earned from staking the stablecoin will also reduce.
- As noted earlier, the choice of a stablecoin staking platform should be preceded by proper safety checks and research. An unsecured platform may be at risk of a breach of security.
How to Stake Stablecoins
Under most circumstances, the process of staking stablecoins is relatively straightforward. Explained below are the basic steps.
Buy a stablecoin. This can be done using a reliable cryptocurrency wallet or exchange.
Choose your preferred lending platform and deposit a certain amount of stablecoin there.
From the options provided on the platform, choose how long you intend to lock your stablecoins. When the time expires, you can withdraw your deposited amount alongside the interest you earned.
Some platforms also offer flexible staking options; you can withdraw at any time. This option often means lower yield. However, it is also a good choice, especially if you’ll be needing the funds anytime soon.
Users can earn interest by locking their stablecoins in lending platforms for a selected period of time.
While considering stablecoin ‘staking’ or lending, the type of stablecoin and the platform to be used should be selected carefully to minimize risks.