Stablecoins are not currency. While they are an important part of blockchain’s development and can be a component of your crypto investing strategy, they are anything but “risk free”. Like any other crypto asset, do not invest anything in them that you cannot afford to lose. Given the importance of paying your tax obligations, putting the money intended for your tax bill into a stablecoin may not be the best idea. Even if it does end up working out, understand that the maneuver is not without risk.
At the end of our last article advising that you set aside money for taxes as the transactions occur, we had a short footnote on this risk of stablecoins and how they are not currency. But the topic deserves to be expanded on.
Stablecoins Are Not the Same as Cash
Stablecoins are one of the most important developments in crypto. Their price stability – especially compared to the significant volatility in the crypto markets – gave a place of relative safe harbor. Without them, token holders would be forced to either immediately cash out for fiat or hold their tokens and ride the price fluctuations. For all of the amazing things blockchain technology can do, the actual currency aspect of cryptocurrency has often been lacking. Stablecoins have helped address that.
On top of that price stability, stablecoins also offer yields well beyond what you could get on fiat in a traditional bank account. With market conditions shifting these rates are being reduced, but it has not been at all unusual to see 8-12% APY paid on USDC/USDT. Before Luna failed, the Anchor protocol was paying nearly 20% APY on UST. And all of this during a period where money market accounts at banks are offering 0-1% interest.
So people flocked (and continue to flock) to stablecoins. You have a “risk free” asset that stays $1 in price, all while earning stock market ROI. What’s not to love?
And as I’ve said before, I’m not against stablecoins. I invest in them. But this point cannot be overstated:
Stablecoins are not currency. They are not FDIC insured. And they can and do go to zero.
Examples of Stablecoin Failures
We most notably saw this with the collapse of Terra Luna/UST. UST’s market cap went from nearly $20 billion to less than $100 million in about a month. And Luna (now Luna Classic) went from over $40 billion to $0 in that same period – although they did rebrand as Luna 2.0, which has a market cap of about $300 million as we write this article.
But that is far from the only example, it’s just the biggest and the most recent. Iron Finance’s TITAN and IRON tokens went from $2 billion to effectively $0 when they had a similar bank run on their stablecoin protocol. MakerDAO’s DAI has struggled to hold its peg in the past, although it has typically traded above $1 in those instances, not below it. Tron’s USDD project has already depegged just a few months after launch.
And those are just the bigger projects. Ever heard of any of the following?
- Basis Cash
- SafeCoin
- OUSD
- BitUSD
- NuBits
- CK USD
- BitUSD
- DigitalDollar
- Empty Set Dollar
I only remembered one or two of those, but those are just some of the stablecoins that have failed in the past few years. I’m sure there are smaller ones that have not had articles written about them.
Different Types of Stablecoins
Now, admittedly, most if not all of those are what they call “algorithmic stablecoins”. At least in their current form, I am not a fan of these projects at all – which given their track record should be no surprise.
There have been countless in-depth articles written on how each of these types of stablecoins work that do a better job than we could, so we won’t rehash them. For the purposes of our discussion here, it’s fair to say that the other three categories are reasonably simple: the stablecoin is backed/collateralized by some kind of other asset – cash or cash equivalents, other crypto tokens, or commodities like gold.
Fiat-backed stablecoins would seem to be the least risky, since they do not have the same risk from market volatility that the other three categories do. But again, and this cannot be overstated:
They are not cash.
Security of Bank Deposits vs. Stablecoin Deposits
In the unlikely event that your bank fails (there were only four bank failures in the US in 2020), up to $250k is insured by the FDIC. That’s pretty low-risk – especially since that $250k limit is “per depositor, per insured bank, for each ownership category”, so you can spread out your funds to have quite a bit more than $250k insured. And the entire US government/USD itself is unlikely to crash. If it does, we all have much bigger issues than the loss of our bank deposits.
But stablecoins are still only as good as:
- The company or protocol that backs them
- The exchange or wallet where you hold the funds
Even though they are fiat-backed, if the company behind a stablecoin gets into trouble then the stablecoin itself will be at risk. Tether is the world’s largest stablecoin, but has faced numerous lawsuits and government probes. Most recently it came to light that it is backed with “non-U.S.” government bonds. If anything happens with the company, then USDT could easily crash.
But people especially seem to forget that second point: even if the coin itself does not fail, where you hold the funds also has some risk. The exchange could be hacked, your keys could be stolen, or the exchange itself fails.
We’re seeing that last point right now with Celsius freezing withdrawals. You may have your money in USDC (which we’ve noted before seems to be the most transparent and stable of the stablecoins, although of course not without its own risk), but if it’s deposited on an exchange that fails, your money is lost the same as if the token itself had failed.
Are Stablecoin Deposit Rewards Worth the Risk?
That’s especially important, because the main reason people want to hold stablecoins is for the yields. There’s no real reason to keep them on a cold wallet since there is no earning potential. If they aren’t going to be held somewhere earning interest, you’d be better off having actual fiat in your bank account. So the vast majority of stablecoins are on deposit with some protocol or centralized exchange.
And if that money is needed to pay your taxes and something happens to the exchange, you are absolutely hosed.
Again, I am not entirely against this strategy. If you have a $100,000 tax bill and set it aside as stablecoins on a centralized exchange, you could earn $10,000 of interest income. That’s not inconsequential money.
But it is far from risk free money. Understand the inherent risk of this maneuver before investing money you cannot afford to lose in stablecoins.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
