Tax Law and News In stability we trust: Cryptocurrencies provide inflation-beatable yields Read the Article Open Share Drawer Share this:Click to share on Twitter (Opens in new window)Click to share on Facebook (Opens in new window)Click to share on LinkedIn (Opens in new window) Written by Sonia Dumas Modified May 23, 2022 7 min read Life costs more. Traditional savings rates are dead. The annual inflation rate for the United States is 7.9%—the highest since January 1982—while traditional saving accounts are on life support, yielding less than 0.5%. As of March 2022, even the classic, risk-free 30-year Treasury bill fluctuated just below 2.6%. In this environment, where will your clients find yields to beat inflation, outpace the cost of living, and grow their investments? Consider advising your clients on how certain cryptocurrencies provide inflation-beatable yields with much less volatility, as seen in Bitcoin’s price movements. Safety, security, and consistency are a core set of needs that each of us seeks to satisfy. To gain certainty in our lives, we seek to earn a living, have a comfortable place to live, protect what we treasure from bad actors or misfortune, and provide for our futures as we age. This need for stability often leads us to work with people or organizations we trust to create our personal firewalls of security. The challenge is that today’s technological and geopolitical climate is melting the ice of trust we’re all used to skating on. In code we trust Even in crypto, the essential need for stability is tightly woven into protocols, decentralized applications (dApps), and blockchains that seek to rival or support Bitcoin’s original vision to shift trust from third parties to code. Hence the saying, “In code we trust.” The crypto market is an emerging, lucrative, speculative, and unrelenting disruptor to the 21st Century perception of money. With innovation comes experimentation and price discovery—and both are naturally unstable. The solution to create a safety net of stability in crypto was the creation of stablecoins. They have managed to balance risk, rewards, and stability for the crypto ecosystem—so far. Stablecoins are cryptocurrencies that claim to be backed by a commodity, fiat currencies, or algorithmic code. Think gold, dollars, euros, pounds, or a mathematical equation. In theory, a stablecoin retains a 1:1 ratio. As of March 2022, stablecoins represent more than $180 billion of the current crypto market cap, and more than $2 trillion as of March 29, 2022. If you sell Bitcoin for $100 into a U.S. Dollar-backed stablecoin (Tether/USDT or USD Coin/USDC), it will relatively hold closely to $100. There are times during periods of high volatility when a stablecoin can experience a shift from its anchor, ranging from $1.01 to $0.89, for example. Traders usually grab these arbitrage opportunities, which helps restore the stablecoin back to its 1:1 ratio. The current largest stablecoin, Tether, started trading in February 2015, five months before Ethereum’s initial smart contract release in July. Showing that long before Decentralized Finance (DeFi) launched in 2018, stability was proactively created to soothe that deeply ingrained need for certainty. Stablecoins act as a psychological and financial safety net, as traders and investors experiment with digital assets. The psychological need for stablecoins Consider the real fear of fiat-devaluation and depreciation. In 2022, Egypt devalued its pound by 14% after investors pulled billions of dollars out of the Egyptian treasury markets. From 2011 to 2021, the euro depreciated by 15% against the US dollar. And then there’s Venezuela, with its 686% hyperinflation in 2021—a compounded result of heavy money printing and deficit spending. Investors and traders fear seeing their purchasing power diminished due to circumstances outside their control, based on monetary policy and geopolitical controversies, for example. Concerns over the long- and short-term consequences of money printing—debt monetization, quantitative easing, and modern monetary theory—have led many crypto users to seek refuge in stablecoins. Trusting unemotional code (assuming it’s decentralized) can feel safer in this current global regime of persistent uncertainty. As global fiat-currencies are stress tested in an environment many global citizens have never witnessed simultaneously, the desire to survive and find financial sanctuaries is at code red. The financial lure of stablecoins Stablecoins provide higher yields at 6%-19%, and relatively lower risk and volatility than Bitcoin and alt coins. In the early 1980s, U.S. savers had access to earning 10%-12% yields on low-risk certificates of deposit (CDs). Today, low-risk also means low-yield in traditional finance. The average savings account yield is less than 1% and as low as 0.01% at major banks. This hardly makes a dent in real inflation. The hunt for inflation-beating yields is one of the drivers of crypto’s adoption. Let’s do a quick comparison of yield opportunities TradFi (retail, commercial, and investment banks, as well as FinTechs) and DeFi (decentralized finance). The average annualized returns across major categories of mutual funds for 2021 were about 12%. Mutual funds outperformed five-year CDs at 2% and 10-year annualized real estate investments at 7%. Investors are accustomed to the risks and volatility of these traditional financial assets. Longevity is a foundational element of trust and stability. Every time it’s stress tested, crypto continues to overcome the hurdle and survive. Within crypto, one of the simplest and original ways to earn yields is to lend stablecoins in return for a variable interest rate. According to Staking Rewards, the lending yields or rewards as of March 2022 for major stablecoins, such as DAI, USD Coin, Tether, and TerraUSD, ranged from 6% to more than 19%, depending on the platform being used. As a basic savings or capital preservation strategy, stablecoin lending can turn unproductive fiat-currencies sitting in yield-starved bank accounts into compounding digital asset machines. Making money more productive, fluid, flexible, and stable is actively being coded into countless crypto projects. Stablecoins are at the forefront of this innovation. As risk-free as taking honey out of a beehive bare handed You get the point. Wear gloves. Yes, there are risks with using stablecoins. Here are three questions to consider when evaluating stablecoins as an inflation-hedge: Is there proof of the claimed reserves? In Oct. 2021, Tether was fined $41 million for misrepresentation of their dollar reserves. Since then, Tether—seeking to not lose its market dominance—has now provided quarterly transparency reports about reserves breakdown, which include cash, cash equivalents, corporate bonds, secured loans, and digital tokens. USD Coin provides monthly reports on its reserves, which are entirely in cash and short duration U.S. Treasuries. How stable is the underlying asset? Ultimately, stablecoins are only as stable as the asset they are pegged to. And even then, during times of high volatility, the price can deviate from the underlying asset. To date, dollar-pegged stablecoins have proven to be the most relatively stable underlying asset. Unfortunately, the same level of relative stability can’t be said about gold-pegged stablecoins. Confiscation and proof of reserves are common risks with gold, compounded by smart contract risks, when considering gold-back coins. Who governs and regulates the coin? Most stablecoins are not decentralized. They are managed by a central entity. They are subject to the policies of a private company and the regulatory jurisdiction they reside in. The reliability of the issuing entity is critical to price stability and adoption across DeFi. There are trending projects such as TerraUSD, which is decentralized algorithmic stablecoin. It maintains its $1.00 equilibrium through its reserve asset LUNA (along with Terra USD, two native tokens of the Terra network) and a complex algorithm to keep it stable. With smart contracts balancing supply and demand dynamically, its appeal and adoption across DeFi continues to attract investors and traders alike. Time will tell how well it thrives when the market is fearful of missing out on buying and panic selling. Whether centralized or decentralized, regulatory risks must be weighed. Right now, there is no global consensus about how to regulate stablecoins. Lots of chatter, but nothing definitive to date. Global leaders are concerned about the challenges these alternative internet currencies pose to the status quo international payments and settle system. Time and continued innovation will carve a path forward. What’s fascinating is that once an investment opportunity stabilizes, so does its yield. Our collective need to feel safe and secure also comes with accepting lower returns. For a window in time, stablecoins are so far successfully balancing lower-risk with higher-yields. Helping your clients explore what stablecoins can do for idle cash reserves, even if only out of curiosity, is just one way to start strategically researching how to protect or insulate the purchasing power of your cash against rising inflation. Previous Post Celebrate Earth Day the tax-wise way Next Post May 2022 tax and compliance deadlines Written by Sonia Dumas Sonia Dumas is the chief editor at AltMonie.com. She helps small businesses and CPAs get educated about the risks and opportunities powered by cryptocurrencies and the Web 3 economy. Find Sonia on LinkedIn at https://www.linkedin.com/in/soniadumas/. More from Sonia Dumas Comments are closed. Browse Related Articles Tax Law and News Best practices in cryptocurrencies Client Relationships Blockchain 101: Implications for Your Practice and Clie… Advisory Services 3 ways you can help your clients navigate crypto Tax Law and News What you need to know about the Inflation Reduction Act… Tax Law and News Home Energy credits under the Inflation Reduction Act Tax Law and News Clean vehicle credits: Inflation Reduction Act Tax Law and News Tax planning opportunities in estate planning Client Relationships Help Your Clients Plan for a Practical and Productive R… Tax Law and News Dealing With Cryptocurrency During Tax Season Tax Law and News IRS announces tax year 2023 changes to the standard ded…