Galoy Inc., the team behind El Salvador’s Bitcoin circular economy wallet, Bitcoin Beach, is adding a new feature to this infrastructure: synthetic US dollars backed by bitcoins.
Often perceived as a need by citizens of developing countries, a BTC-backed representation of the US dollar promises to allow anyone to hedge against bitcoin’s daily volatility. While it could be argued that bitcoin is the best currency and could be used as such in day-to-day transactions, some see the value of saving in BTC and spending in USD – and the new product feature of Galoy, Stablesats, allows users to do all of this on Bitcoin.
“With Stablesats-enabled Lightning wallets, users can send, receive, and hold money in a USD account in addition to their default BTC account,” Galoy CEO Nicolas Burtey said in a statement sent to Bitcoin. Magazine. “While the dollar value of their BTC account fluctuates, $1 in their USD account remains $1 regardless of the bitcoin exchange rate.”
Notably, Galoy’s implementation differs from a common “stablecoin” such as Tether’s USDT in that there is no token – it’s just stabilized bitcoin in a dollar balance.
Galoy also shared that he raised $4 million to further develop GaloyMoney – its open-source bitcoin banking platform, versatile API, and enterprise-ready Lightning gateway for organizations to access Lightning payments. The round was led by Hivemind Ventures, with participation from Valor Equity Partners, Timechain, El Zonte Capital, Kingsway Capital, Trammell Venture Partners and AlphaPoint.
“The open-source GaloyMoney central banking platform includes a secure back-end API, mobile wallets, point-of-sale applications, accounting register and administrative controls,” the company said in a statement.
How does Stablesat work?
stablesat is able to offer bitcoin backed stable dollar balance via inverse perpetual swaps. The wallet pledges the user’s bitcoin as collateral to a centralized exchange –– OKX in the case of Galoy –– to purchase these derivative contracts, which are used to hedge the BTC that backs the dollar account in the wallet .
Reverse perpetual swaps are denominated in fiat currency, but any gain or profit, as well as margin (collateral), is valued in bitcoin. As such, the user’s dollar account suffers unrealized BTC gains if bitcoin’s price drops or unrealized BTC losses if bitcoin’s price rises – while maintaining a stable dollar balance.
Here’s a simplified example: Assuming the user holds 1 BTC on their Stablesats-enabled Lightning wallet and wants to convert it to a USD balance, that 1 BTC would be pledged as collateral to purchase the corresponding amount of perpetual swap contracts inverses. Assuming a bitcoin price of $20,000 and a contract value of $1, the user’s synthetic balance of $20,000 would represent 20,000 contracts of $1 each and 1 BTC as collateral.
If bitcoin’s price rose to $40,000, the user would still be holding $20,000 worth of contracts –– because their dollar value doesn’t change –– but now, with $20,000 only worth 0.5 BTC, this would result in an unrealized loss of half a bitcoin. Conversely, if the bitcoin price fell to $10,000, the user would still hold $20,000 worth of contracts – but now that amount would be worth 2 BTC, resulting in an unrealized gain of 1 BTC.
Through this mechanism, Galoy is able to “stabilize” the user’s bitcoin on a US dollar-denominated account. It is important to note, however, that this dollar balance would be used to transact on the Bitcoin network; Stablesats does not interface with the traditional banking system.
What are the risks ?
The first –– and perhaps the biggest –– risk involved in implementing Galoy is counterparty risk. As a transaction takes place in the background on behalf of the user with a centralized exchange, which also retains the user’s bitcoin collateral, there is a real risk of losing funds due to external issues.
As seen in recent events, exchanges and lenders are facing liquidity issues which result in the blocking of user funds are not uncommon. Centralized guard problems dates back to the infamous Mt. Gox exchangeand users should therefore weigh the pros and cons of embarking on such arrangements beforehand.
Other risks include automatic deleveraging (ADL) and funding becomes negative over a long period. ADL can occur in volatile market conditions where sell-offs trigger the closing of profit positions – leading to an under-hedged situation in the stablesat environment. Funding, on the other hand, determines the bias of the market; if the funding is negative, the shorts pay the longs. This means that funding remaining negative for an extended period could eat away at shorts –– which could hurt Stablesats implementation.
– Thanks to Dylan LeClair for his comments and information.