Imagine you are placing a bet on a sporting event. There are numerous possible outcomes and the outcomes themselves are highly volatile. Now imagine that instead of using dollars, pounds, or euros you placed a bet using the betting receipts from another bet which in itself in an unknown outcome. In this situation neither you or the house you are placing bets with would know the actual measurable value in stable terms.
When you make a prediction on the value of an asset at a future point in time and if you get it right, you want to be sure that you will make a positive return on your investment, else the entire trade or participating in a derivatives trade would be pointless. You would never accept losing money on a winning trade.
This question may seem a little weird however, it is a very valid possibility if you participate in a derivatives trade using a measure of money that in itself is volatile. Most cryptocurrencies beyond Bitcoin (BTC) and Ether (ETH) can be quite volatile over a course of a few days. If you were to enter a derivatives contract or buy options or forwards using such volatile cryptocurrencies, it could well be that even if you receive more of that volatile currency and earn a theoretical positive return on investment when counted in that specific currency or coin, however, it could actually translate into lesser value when counted at stable value of usual fiat currencies like Dollar or Pound.
Stablecoins on the other hand are what it says on the tin, stable. Stable-coins are represented as a unit of value that is familiar to most people, such as a U.S.Dollar or British Pounds or Swiss francs. There are various kinds of stable-coins based on different valuation and trading mechanisms, however, the ones that are most favoured are 100% backed by actual reserves of the currencies they represent. For example, one US Dollar denominated digital stablecoin called USDC represents a physical dollar in the real world. The value of USDC remains mostly between a fiat world value of $0.97 and $1.03. There are other formats of stablecoins too that are not as stable, for example, DAI, an algorithmically balanced stable coin that can fluctuate vastly between a fiat world value of $0.7 and $1.3. Knowing these differences between different stablecoins means choosing your stablecoin properly is very important if you wish to minimise your risks. CBDCs (Central Bank issued Digital Currencies) are likely to be the most stable coins when they become mainstream, however, for now (as of December 2020) we should not take them in contention.
Let’s go back now to what would be the best digital currency or token when you are participating in derivatives trades, especially decentralized or defi derivatives.
When you enter a derivatives market and buy options or futures, your money is generally parked or ring-fenced for a period of time till the outcome is known at the end of contract. During this time the only variable that should dictate a positive return on your investment or not should only be your prediction of asset value being correct or not. You should not have to worry about the volatility of the currency you used to make that bet.
See how a potential comparative view between these two scenarios, using volatile tokens or altcoins pans out against a stable-coin led derivatives contract. Both Adam and Dave thought that Bitcoin will be at least $ 19500 on 16th of December 2020 at 1200 CET. They both entered a derivative contract on the 11th of December 2020 that was slated to give them a 1.5x return if they were right. However, Adam chose to enter using XRP and Dave used USDC
|Date of entry||11th of December 2020||11th of December 2020|
|BTC price predicted||$19500 +||$19500 +|
|Value at entry||172 XRP at $0.58 (roughly $100)||100 USDC (roughly $100)|
|BTC Price on 16th Dec. 2020||$19783||$19783|
|Total returns received||258 XRP at $0.45 = $116||150 USDC (roughly $150)|
In this example, using precise and correct market data, you can see that Adam underperformed Dave vastly in generating positive returns on investment while entering the same derivative contract, predicting the same future BTC price, yet ending up with much lower return.
Dave had the certainty of value he will receive and in this specific example generated almost 3x more profits that Adam. We don’t claim that the value of a volatile token or digital cryptocurrency will always be against you. It could very well be that in a reverse situation where the price of XRP actually went up in the same time window, Adam would outperform Dave.
What is important though is that you have stability in the measure of what you use (USD, stablecoins, crypto, altcoins, whatever) to enter contracts that speculate on the future volatile value of another financial asset. Adam could have converted his XRP to USDC at entry into contract and converted back the $150 into XRP at exit and received 333 XRP instead of the 258 XRP he ended up with. This further goes to demonstrate that even if you are very keen on holding certain coins as an investment in itself; what may work best over time is to always use a stablecoin when entering defi derivatives that allow you to speculate on volatile assets.
To offer a better risk management for our users CloseCross.com has decided to opt for USDC as the stablecoins which will be used for all our VPFs.
Founder, CloseCross - Decentralized derivatives driving democratic participation