Although Bitcoin is sound money in every sense of the word, one problem that persists for people who wish to use Bitcoin for their daily transactions is the short-term volatility of Bitcoin when compared to other currencies like USD or the Euro. The price of Bitcoin is determined by the market forces of supply and demand. A short-term decrease in the demand for Bitcoin could result in a lower price even though this does not in any way make Bitcoin less valuable as a transfer of value across the internet. Stablesats were created to address this particular use case.
What Is Stablesats?
Stablesats is a form of synthetic USD created through futures contracts, providing a stable currency backed by Bitcoin and pegged to the value of the US dollar. This means that for Stablesats to be used in a Bitcoin wallet, there is to be an integration with an exchange which would create a contract that agrees to sell Bitcoin for USD with the current price of Bitcoin at some time in the future. This essentially locks the current USD value of Bitcoin in the wallet to USD and ensures that the value of USD held in the wallet remains the same regardless of changes in the value of Bitcoin over time. The financial mechanism that enables this is to happen is called a perpetual inverse swap.
What Are Perpetual Inverse Swaps?
Normally, perpetuals swaps are a form of derivative contract which parties enter into that “derive” the present value from an underlying asset – asset in this case referring to Bitcoin. Essentially, perpetuals are derivative contracts with no expiration and this is possible since the assets being swapped are digital assets which do not degrade over time.
Hence, simply put, a perpetual swap of Bitcoin is an agreement to exchange Bitcoin for USD based on the current value of Bitcoin at the time the agreement is made. However, unlike traditional futures contracts, it doesn’t have an expiration date and can be held indefinitely, making it a continuous trading instrument. Note that in this case, a user will be getting value returned in the form of Dollar per bitcoin (USD/BTC)
Now, a perpetual inverse swap of Bitcoin is like a reverse of the above. In this agreement, Bitcoin is exchanged for USD based on the current value of Bitcoin at the time of the agreement with no expiration date, however, what distinguishes the perpetual inverse swap is that the value is returned to the user in the form of BTC/USD, not USD/BTC. This means that any profit or loss from the swap is calculated and settled in Bitcoin, rather than in dollars. So to create a Stablesats or synthetic USD, one needs to take a “short” position on the perpetual inverse swap of Bitcoin with an assumption that the price of Bitcoin will go down.
Let’s break it down with a simple example:
Regular BTC Perpetual:
Imagine you have a contract where you’re trading Bitcoin, but the profits and losses are calculated in dollars. Let’s say you enter this contract when 1 Bitcoin is worth $26,000. You buy 2 Bitcoin, so you’re essentially holding $52,000 worth of Bitcoin. If the price of Bitcoin goes up to $30,000, you’ve made a profit. You can sell your 2 Bitcoin for $60,000, making a $8,000 profit in dollars.
However, if the price of Bitcoin decreases to $24,000, you would incur a loss. In this case, you could sell your 2 Bitcoin for $48,000, resulting in a $4,000 loss in dollars compared to your initial investment of $52,000.
BTC Inverse Perpetual:
Now, in an inverse perpetual swap, you’re trading Bitcoin, but the profits and losses are calculated in Bitcoin. Using the same example, you enter when 1 Bitcoin is worth $26,000. You buy 2 Bitcoin, so you’re holding 2 Bitcoin. If the price of Bitcoin goes up to $30,000, nothing changes – your Bitcoin is still worth 2 BTC. Conversely, if the price of Bitcoin were to decrease to $24,000, you would still be holding 2 Bitcoin. In this case, although the value of your Bitcoin in dollars has dropped to $48,000, you haven’t lost any actual Bitcoin. This is because you initially bought and still hold 2 Bitcoin.
How is Synthetic USD then generated?
Synthetic USD is derived from holding a short position on the Perpetual inverse swap of Bitcoin. Here is a simple illustration of how this works:
- Imagine Alice wants to generate synthetic USD from her Bitcoin when the current Bitcoin price is $10,000. To do this, she would need to send atleast 10,000 Satoshis (Sats) which is equivalent to $1 in this scenario (100,000,000/10,000). This $1 would serve as the unit value of each contract she needs to open for the amount she wishes to send (e.g if she wishes to have $12 worth of synthetic usd, she would need to create 12 perpetual inverse swap contracts of 10,000 sats each).
- Now, if the price of Bitcoin goes down to $5,000 then Alice’s position would make a profit of ((1/5,000 – 1/10,000) * 100,000,000) = 10,000 sats and when she closes it she would get 20,000 sats (10,000 initial margin + 10,000 profit). You can see that 20,000 sats are exactly worth $1 at a Bitcoin price of $5,000 so the same dollar value in Bitcoin is maintained.
- Conversely, if the Bitcoin price goes up to $20,000 then Alice’s loss would be ((1/20,000 – 1/10,000) * 100,000,000) = 5,000 Sats. If she closes the position at this point she would be returned 5,000 Sats (10,000 initial margin – 5,000 loss). However, at a Bitcoin price of $20,000, 5,000 Sats are exactly worth $1 so you again maintained the same dollar value in Bitcoin.
Hence, you are always thinking in terms of Bitcoin, not USD. So, if the Bitcoin price goes up, you gain more Bitcoin, and if it goes down, you lose Bitcoin but the value of Bitcoin owned against the dollar remains the same. The Lightning Network facilitates this process by ensuring quick swap of BTC for USD and vice versa through an integration with an exchange. Some exchanges which currently support the shorting of Bitcoin perpetual inverse swaps include OKX, BitMEX and Kollider
Conclusion
Introducing newcomers to Bitcoin often raises concerns about its price volatility. Many are accustomed to the perceived stability of traditional fiat currencies, which can lead to skepticism about Bitcoin’s viability as a currency. However, emerging technologies like Stablesats and Synthetic USDs mark significant strides in addressing Bitcoin’s volatility. It’s crucial to highlight that, unlike stablecoins like USDT and USDC, Stablesats rely solely on Bitcoin’s value in relation to the dollar for their stability. This distinction sets it apart in the area of stable digital assets, adding a unique dimension to the ever-evolving bitcoin ecosystem.
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