The move towards a bitcoin standard will not be a straight line; it will be filled with many curve balls, as the everyday hodler will tell you. As bitcoin price discovery continues, as more people come to terms with the network and the asset, there are going to be times of high volatility and periods of low volatility.
Every person on the planet will have a different stomach for it; some have enough of a cash buffer and conviction in bitcoin not to worry, but others might not be so fortunate and are looking for short-term price stability in fiat terms but still retain exposure to bitcoin.
So how do we deal with having bitcoin while it’s being monetised but also be able to transact as a medium of exchange without too much gritting of the teeth? Well, the market has spoken with the solution, and that has been stablecoins, predominantly USD-based stablecoins.
The stablecoin comes in various forms from
- Centrally issued cash backed
- Centrally issued asset-backed
- Algorithmic stablecoins
- Derivative stablecoins
All with the aim of tackling the problem that persists for people in a Bitcoin economy. The short-term volatility of the bitcoin exchange rate. When the bitcoin price drops, it can lessen the purchasing power of sats and make it harder to pay for dollar-priced goods and services and keep pace with settlement.
This creates friction and uncertainty, causing merchants and consumers to frequently consider selling bitcoin for dollars to ensure they can meet their financial obligations.
There have been several attempts to bring stablecoins to bitcoin like
- USDT on Liquid Network
- Bitcoin-backed stablecoins on Liquid
- USDT on the Omnilayer
- USDT on Lightning via Omnibolt and Synonym
- Stablecoin tokens via RGB
- Stablecoin tokens backed by bitcoin via TARO
What are synthetic USD?
The idea of synthetic dollars has been the topic of articles and conversation for years. BitMEX even described the idea in 2015. Burtey thinks that with the state of Lightning adoption and the emergence of circular bitcoin economies globally, now is the time for this solution to take off.
The current Stablesats implementation uses bitcoin derivatives markets, specifically, an instrument called perpetual inverse swap.
Sebastien Verreault, lead contributor to the Stablesats GitHub repository, shares thoughts on the future:
“The Stablesats rollout represents the first step in an exciting new driver for Lightning adoption. We see the integration of more exchanges, hedging strategies and currencies furthering resiliency and optionality. Ultimately, we can unlock the ability for every Lightning user to choose their own units of account without ever leaving the network.”
How Stablesats work
Stablesats is an alternative to stablecoins or fiat bank integration, Stablesats uses derivatives contracts to create a bitcoin-backed synthetic dollar pegged to USD. This enables dollar-equivalent USD accounts inside of Lightning wallets, solving one of the biggest problems for people using bitcoin for everyday transactions: short-term exchange rate volatility.
When Stablesats launches in the Bitcoin Beach Wallet (currently in beta), users will get a second account added to their wallet – they will have a BTC account and a USD account.
Both accounts can be used to send and receive bitcoin, and users can instantly transfer value between these accounts. Value held in the USD account will not fluctuate with the price of Bitcoin.
There is no stablecoin or token other than bitcoin underlying Stablesats, which means better interoperability and lower fees for users. And because the feature doesn’t require fiat banking system integrations, Stablesats is something that bitcoin banks and wallet projects can bring to market quickly. The regulatory approvals required to offer Stablesats will vary by jurisdiction.
“Bitcoin has brought digital transactions to previously unbanked communities across Latin America, Africa and beyond.. However, its volatility makes managing financial obligations difficult. With Stablesats-enabled Lightning wallets, users are able to send from, receive to and hold money in a USD account in addition to their default BTC account. While the dollar value of their BTC account fluctuates, $1 in their USD account remains $1 regardless of the bitcoin exchange rate.”
– Galoy CEO Nicolas Burtey
A brief history of synthetic USD
Methods for creating synthetic USD have been discussed and implemented for many years:
- In 2015, Arthur Hayes outlined how to create, store, and spend synthetic USD.
- In 2021, the Standard Sats project introduced the idea of “eurobitcoins” during a hackathon.
- In early 2022 Kollider published a Twitter thread recapping ideas and projects under the “synthetic stablecoins on Lightning.”
There are already synthetic stablecoins on the #LightningNetwork today ⚡— Kollider⚡ (@kollider_trade) February 23, 2022
A thread 🧵 on what they are, how they are created, and who uses them.
The following is not investment advice, it’s purely an educational overview. Do your own research. pic.twitter.com/jg8lkDsCQZ
The time for synthetic fiat currencies has arrived, with stabelsats taking the idea and rolling it out into the Bitcoin Beach Wallet. Bitcoin banks using Stablesats can deliver a meaningful solution to millions of Lightning Network users seeking volatility protection.
Stablesats offers a third option for Bitcoin banks wishing to solve the volatility problem for their users. The chart below compares some of the tradeoffs between the two typical options – stablecoins and fiat banking integration – and points to a future fourth option based on Discreet Log Contracts (DLCs).
How is Stablesats different from the algorithmic stablecoin projects, some of which have recently blown up?
Algorithmic stablecoins are typically not fully collateralized, which makes them vulnerable to a run on the bank.
The derivatives contracts placed to create Stablesats are fully collateralized with BTC – for every dollar liability, there is an equivalent dollar worth of value in bitcoin.
When you’re holding stablesats in your wallet, you’re not exposed to the backing of an entire ecosystem and the liquidity but only the position you took and the short or long position the “bitcoin bank” has taken to hedge against the volatility.
Unlike centralised stablecoins such as USDT (Tether) and USDC hosted on different blockchains, you still have counter-party risk from the issuer of the token, the blockchain, and the wallet provider and have interoperability issues as you need to swap between chains.
With Stablesats, users don’t have to worry about which blockchain or stablecoins their counterparty uses. Stablesats offers a way to hold and transact dollars that is fully interoperable with anyone using bitcoin and Lightning.
Is it possible to use “physical” USD from a bank account to send and receive payments over Lightning?
Stablesats is a synthetic USD that only exists through the backing of bitcoin and a derivative position, which isn’t interoperable with other versions of USD, but is merely a settlement option for those looking to transact in USD via the Lightning network.
Galoy is working on this functionality independently to get institutions and merchants to accept stablesats and allow for exchange and redemption for physical USD.
If you’re interested in providing a stablesats to physical USD exchange, then reach out to the team at Galoy with your requirements, and they can assist you in building out the tech stack as well as advise you on the legal requirements involved in the process.
No, today Stablesats only relies on the bitcoin payment network to work.
Synonym, Taro or RGB that are enabling tokens on Bitcoin or bitcoin layers while the Stablesats project is focused on creating stable value in USD. There is no token involved other than sats, and only Bitcoin payment rails are being used.
Since Stablestats uses derivatives products, it may require regulatory approval in some countries.
Every fiat product has some risk. For instance if you hold fiat in a bank account and the bank goes under, you are at risk of losing funds. Similarly, when you stabilize sats, some of the magical powers wear off.
Risks to consider for Stablesats include the following:
- Counterparty risk with the exchange. If the exchange goes under, the collateral may be unrecoverable.
- Derivatives exchanges have auto-deleveraging for perpetual contracts. The position could be closed despite being in profit. This will lead to an under-hedging situation.
- Funding goes negative for an extended period of time. Historically there has been on average more longs than shorts on derivatives exchanges. In this environment, funding is revenue-generating for short positions. This might not stay true in the future.
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