Stablecoins and security tokens combine the features of blockchain with the attributes of traditional assets. The former is designed to address the high volatility of cryptocurrencies, although this is achieved at the expense of giving up potential returns. The good news is that some security tokens, especially asset-backed tokens, can achieve both stability and return. Read on to find out how the two types of blockchain-based tokens differ and which type offers more opportunities.
What Are Stablecoins?
A stablecoin is a blockchain-based token whose price is pegged to an underlying real-world asset, most often a fiat currency such as the US dollar. While stablecoins can be pegged to commodities and other assets, the majority of them are backed by fiat currencies based on a 1:1 ratio, and USD digital currencies are currently dominating the market.
As of 2022, the three largest stablecoins by market cap are Tether’s USDT, Circle’s USDC, and Binance’s BUSD, which together account for about 13% of the entire crypto industry, with an aggregate market cap of $130+ billion as of October 2022.
Stablecoins have rightfully become one of the most important assets in the crypto industry due to their ability to act as a high throughput bridge between traditional finance (tradefi) and the blockchain space. Years after the release of the Bitcoin whitepaper and the rapid growth of utility tokens, institutional investors were still wary of getting exposure to crypto because of the high volatility and difficulty of quickly cashing in during a bear market that could pop up all of a sudden even by defying all technical and fundamental analysis logic.
Stablecoins came to the rescue by narrowing the gap between tradefi and the emerging crypto industry. This new asset type has brought more institutional and retail investors to the blockchain space and has boosted liquidity across decentralized finance (DeFi) and the wider crypto markets.
DeFi is especially important because it may challenge the financial system by proposing alternative approaches to conduct financial operations such as lending, trading, insurance, and so on. Banking giants ING and Bank of America have separately concluded that DeFi was potentially more disruptive than Bitcoin itself. Stablecoins account for 20% to 30% of the entire DeFi market in terms of total value locked (TVL).
The main goal of stablecoins is to address the high volatility of cryptocurrencies and act as a gateway to cryptocurrencies and blockchain applications. They can be used on both sides, as they can be integrated into both blockchain and traditional finance use cases.
Stablecoins have been so far quite successful because of their unique ability to merge the benefits of fiat currencies, which relate to price stability, liquidity, and convenience, with blockchain features, including decentralization, transparency, security, and high speed of transactions at a low cost.
Types of Stablecoins
Today, we can distinguish three main types of stablecoins based on their architecture and collateral structure, which defines how they work:
- Fiat collateralized – stablecoins with fiat collateral rely on a direct peg based on a 1:1 ratio. As a rule, the fiat collateral is stored in a reserve vault with the issuer or a financial institution and must be proportionate to the number of stablecoin units in circulation. For example, if the issuer has $1 billion in fiat, it must distribute 1 billion stablecoin tokens. USDC is a good example of a reliable USD stablecoin with fiat collateral.
- Crypto collateralized – crypto-collateralized stablecoins rely on cryptocurrencies, such as Ethereum, as collateral, although their price is pegged to a fiat currency, such as the US dollar. The benefit of crypto-collateralized stablecoins is that they are decentralized and have no single issuer, with all processes being powered by smart contracts.
To mint the stablecoin, the user has to lock his cryptocurrency into a smart contract. Eventually, the user can withdraw the collateral amount by putting the stablecoin back into the smart contract. If you wonder how volatility risks are mitigated, these stablecoins are overcollateralized, meaning that you typically have to put $2 worth of crypto to receive $1 worth of the stablecoin.
Ethereum-based DAI is currently the most popular crypto-collateralized stablecoin, with a market cap of over $6 billion.
- No collateral – algorithmic stablecoins don’t use any collateral at all. Instead, a system of algorithms and smart contracts act as a central bank, reducing and increasing the number of tokens in circulation when the stablecoin price drops or rises relative to the fiat currency it virtually pegs to. Even though some algorithmic stablecoins proved to work for a while, this category poses many risks, with the crash of Terra USD (UST) already exposing the vulnerabilities of such tokens.
While crypto-collateralized and algorithmic stablecoins boast several benefits revolving around decentralization, stablecoins with traditional collateral are the most practical and thus most popular today.
What Are Asset-Backed Security Tokens?
Asset-backed security tokens share some similarities with stablecoins. However, they’re also fundamentally different. Asset-backed tokens, which are one of the main groups of security tokens, provide holders with ownership rights over real-world assets, such as commodities, real estate, and art. Thus, they derive their value from the underlying asset. Other types of security tokens include equity tokens, which represent company stocks, and debt tokens, which are backed by bonds.
We have already debunked the top 5 myths that are commonly associated with security tokens, and you can read more about that here.
While stablecoins’ main goal is to address the volatility issue, asset-backed tokens aim to boost liquidity while leveraging the same blockchain benefits related to decentralization, security, and convenience of trading.
Liquidity is one of the main promises of asset-backed tokens. In the case of non-liquid assets, such as real estate and art, these tokens can open the door to a broad range of investors. For instance, trading an expensive property for cash may take some time, as it’s more difficult to find a buyer ready to pay the price for it. Thanks to asset-backed security tokens, the pool of potential investors is expanding. Moreover, security tokens have a great feature called fractional ownership, which makes it possible to divide the value and stake of a property or artwork into multiple fungible tokens. With this feature, the non-liquid asset can be sold to multiple investors that end up with partial ownership. Fractional ownership makes the asset even more liquid.
By tokenizing real-world assets, real estate and community markets can become more accessible to retail and institutional investors. Unlike derivatives, which may offer the same liquidity benefits, asset-backed tokens provide holders with ownership rights.
Another great benefit of these tokens is the programmability powered by smart contracts, which allows issuers to embed investment eligibility terms, thresholds, and all kinds of conditions.
While some commodity-backed tokens can fall under the stablecoin umbrella, asset-backed security tokens usually comply with security regulations.
One of the best examples of asset-backed tokens is the United States Property Coin (USPC), which allows holders to become part-owners of an income-producing property portfolio, with the seed asset being a $10 million luxury multifamily property in Venice Beach, California.
Stablecoins vs. Asset-Backed Security Tokens
Traditional investors are more inclined to get exposure to blockchain-based tokens that are tied to some form of real-world assets, and both stablecoins and asset-based tokens are a good start. However, despite their success, stablecoins come with some drawbacks and hidden risks that are generally less known, which may leave asset-backed security tokens as a better alternative. Here are some concerns you should know about:
- Regulatory risk – asset-backed tokens are treated as securities in their jurisdiction, and thus are regulated accordingly if registered, which can give investors peace of mind. On the other side, most stablecoins have not been regulated and are currently in a process of review, with governments trying to tighten the rules over such tokens as part of wider regulatory frameworks for the crypto market. While this eventually might be a positive, stablecoins may lose out on their flexibility, which could hinder the growth of the entire sector.
At the beginning of October 2022, the US Financial Stability Oversight Council (FSOC) – a federal panel tasked with monitoring financial system risks – released an extensive report talking about the crypto risks. The panel, which is led by the US Treasury Department headed by former Fed chairman Janet Yellen, concluded that stablecoins and crypto pose risks to the stability of the financial system, calling for tighter regulations.
A few weeks prior to the FSOC’s report, the International Monetary Fund (IMF) called for global regulation of stablecoins.
- Return on investment – stablecoins might address the crypto’s high volatility concerns, but they don’t provide any potential return due to their fiat peg. It’s basically like holding cash. On the other side, asset-backed security tokens, if invested properly, could still address high volatility while providing returns on top of that. Real estate and artworks are some good examples of assets that can maintain and grow their value over time.
- Inflation – considering that stablecoins are pegged to their underlying fiat, they not only fall short of providing returns but also see their purchasing power dropping at the same pace. Following the unprecedented stimulus measures implemented by the Federal Reserve and other central banks to support economic growth amid the COVID-19 pandemic, inflation has skyrocketed to the highest level in decades. The latest data shows that the US consumer prices index (CPI) surged to over 8% in annual terms, which is the highest in 40 years. Stablecoins automatically borrow the fiat inflation, being plagued with the same devaluation problem given their peg, and this is not the best asset to preserve value in the long term, which some asset-backed tokens can offer.
- Risk of failure – last but not least, stablecoins might not be stable at all. The shocking implosion of UST and Terra (LUNA) – its sister token – has exposed the major risks of such tokens, especially when it comes to algorithmic tokens. However, even mainstream stablecoins like USDT, the biggest one in terms of market cap, are not without their problems. Tether, the company behind USDT, claims that it is backing the token with a mix of cash and bonds, although some investors are concerned this may not be accurate. Previously, the New York state Attorney General found that Tether had no reserves to back USDT in circulation for periods of time.
Such risks are not present with genuine asset-backed security tokens, as they’re already regulated, cannot fail given the backing of the underlying asset they represent, and can provide a return on investment as well as protect from high inflation.
Is USPC More Stable Than Stablecoins?
In the end, some security tokens are more stable than stablecoins, especially in the case of asset-backed security tokens, with USPC being one of the best examples.
USPC helps investors get exposure to the real estate market, which can support lucrative investment strategies that manage to hedge against inflation. The token leverages an institutional-grade blockchain solution and complies with US securities law and regulations. USPC merges the benefits of blockchain with a time-tested investment approach to help investors put their money into real estate conveniently.
By holding USPC, investors become owners of a diversified portfolio of US commercial properties, including multifamily housing complexes, healthcare facilities, and hospitality properties. The real estate assets are located in high-demand urban markets spread across the US. The portfolio is designed to hedge against inflation and is a great alternative to volatile cryptocurrencies.
The asset-backed token provides investors with fractional ownership of an income-generating real estate portfolio.
USPC founder Johnney Zhang is also CEO of Primior, a real estate investment and development firm with more than $1 billion in successfully developed real estate projects. His vast experience is a guarantee of the long-term success of USPC and the investment method used for the real estate portfolio.
Investing in USPC is even more relevant considering the inflation that might be out of control. Since the onset of the pandemic, the M2 gauge representing the USD monetary supply has surged from $15 trillion at the beginning of 2021 to nearly $22 trillion as of today, and the real estate and stock markets are the first to absorb the excess cash. For example, median house prices are directly correlated to the monetary supply.
The value of US real estate tends to appreciate over time driven by the inflation trend. While the annual percentage yield (APY) of saving accounts has increased from less than 1% to over 3%, this is still not enough to hedge against inflation.
With USPC, investors don’t get exposure to a real estate property, as with many asset-backed tokens, but to an entire portfolio aimed at long-term appreciation. The passive returns are also paid in USPC instead of USD, which helps investors secure compound returns.
With risks mitigated to a minimum thanks to being pegged to an entire real estate portfolio, we can confidently say that, in our opinion, USPC is more stable than stablecoins and also has the potential to produce passive income for investors. Of course, we always invite potential investors to seek their own financial advice before investing in any security, digital or otherwise.