Stablesats: Bitcoin's (BTC) "stablecoin" compatible with the Lightning Network.

Thanks to Stablesats, it is possible to hold synthetic dollars on the Bitcoin (BTC) network, similar to a stablecoin. Imagined by the startup Galoy, this innovation solves the problem of Bitcoin's short-term volatility. How does Stablesats work?

16th July 2023
9 minutes to read
This article is a translation of an article from Cryptoast.fr, which you can find here.

And what if Bitcoin had its own stablecoins?

Stablecoins have become an essential tool for the cryptocurrency ecosystem, whether it's to secure profits, temporarily protect against market volatility, or generate returns in decentralized finance (DeFi).

Although there are many different stablecoins in the crypto market, approximately 65% of them are Tether's USDT. But is it the best representation of the US dollar on the blockchain?

The startup Galoy, the creator of the renowned Bitcoin Beach Wallet in El Salvador (now called Blink), leverages a new peg mechanism with Stablesats, enabling near-instantaneous exchanges via the Lightning Network, the famous second layer of Bitcoin focused on scalability and low transaction costs.

What are Stablesats?

Stablesats are not traditional stablecoins but rather derivatives of Bitcoin (BTC) that track the value of the US dollar.

Unlike centralized stablecoins like USDT or USDC, the anchoring of Stablesats to the US dollar is not ensured by holding dollars in a bank account.

Instead, a short position on BTC serves as protection against price fluctuations. Hence the name Stablesats, which stands for stable satoshis.

A short position, also known as "short selling," is an investment strategy where an investor sells a borrowed asset with the hope of buying it back later at a lower price to pocket the difference. Typically, the investor borrows the asset from a third party and sells it in the spot market.

Beyond serving as a peg mechanism or a tool for bearish speculation, shorting can also act as protection against volatility.

Indeed, investment funds can face backlash from their clients even with just a few percentage points of unrealized losses. That's why, although a 5% drop in a week is quite common with BTC, exposing themselves to it can be very risky for these fund managers.

Therefore, opening a short position on 80% of their BTC holdings would allow them to reduce the volatility of their holdings by 80% and thus avoid the anger of their clients.

For Stablesats, the objective is not just to reduce BTC volatility but to stabilize their value to that of the dollar.
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Typical Example of How Stablesats Work

Let's assume that we believe the price of BTC will decrease by next week. To capitalize on this potential drop, we decide to establish a short position.

First, we look for an individual who has 1 BTC and is willing to lend it to us. In return, we offer repayment later with a 1% commission as a token of appreciation for borrowing the asset. Once we have borrowed the BTC, we go to a marketplace (such as an exchange platform) and sell it at the current price, let's say $30,000 in this example.

Now, we have obtained $30,000 in exchange for selling the BTC. Then we eagerly wait for a week, and to our great satisfaction, the price of BTC has indeed fallen to $25,000. With the $30,000 we obtained from the initial sale, we now buy 1.01 BTC (the borrowed amount plus the 1% fee). Finally, we repay our debt by returning the borrowed BTC, while keeping the remaining $4,750.

In general, for this type of operation, it is more common to use a broker who will execute the sale on our behalf. This requires depositing funds in advance and setting up collateral to cover potential losses in case of a significant price increase.

For Stablesats, this short position helps maintain a parity between the value of the dollar and the satoshis associated with the short position.

Let's say we own 1 million satoshis (equivalent to 0.01 BTC), the current price of BTC is $30,000, and we decide to convert half of our satoshis into Stablesats to protect against potential devaluation of BTC.

Then, 500,000 of our satoshis, valued at $150, will be sent to what Galoy calls a "Bitcoin Bank." This bank will hold these satoshis for us and use them as collateral to open a non-leveraged short position at the current price.

In the case of Stablesats on the Blink wallet, the Bitcoin Bank is the crypto platform OKX. So, in our wallet, we now have 500,000 satoshis and $150 worth of Stablesats.

But what happens if the price of BTC drops to $15,000? How can we be sure that the 500,000 satoshis we converted into Stablesats are still worth $150?

Here, the short position fills the gap. If the price of BTC drops by 50% (from $30,000 to $15,000), the short position will have a latent profit of 50% of the initial collateral value, which is $75.

Meanwhile, the 500,000 satoshis held by the Bitcoin Bank have lost 50% of their value and are now worth only $75. This represents a total of $150 between the 500,000 satoshis collateral and the gains generated by the short position.

In this case, if we want to retrieve our satoshis, the Bitcoin Bank will close the position, pocket the $75 profit, repurchase 500,000 satoshis, and send us back $150 in satoshis, which is equivalent to 1 million satoshis.

On the contrary, if the price of BTC increases by 100% (from $30,000 to $60,000), the short position will have a latent loss of -100% of the initial collateral value, which is -$150. This loss, subtracted from the 500,000 satoshis held by the Bitcoin Bank, which are now worth $300, represents a total of $150.

In this case, if we want to retrieve our satoshis, the Bitcoin Bank will close the short position, cover the $150 loss with 250,000 satoshis from our collateral, and finally send us back $150 in satoshis, which is equivalent to 250,000 satoshis.

Thus, regardless of the fluctuation of the BTC price, the peg of Stablesats is guaranteed, and they can be exchanged at any time for satoshis.

Here is a summary diagram of how Stablesats work:[Diagram: Stablesats functioning]

The Specifics of Stablesats

The code of Stablesats is open source and could be implemented in any Lightning Network-compatible wallet, including a network node, allowing everyone to have their own synthetic dollar.

Note that it is possible to send Stablesats to someone who wants to receive satoshis, just as it is possible to receive Stablesats from someone who has sent you satoshis. To do this, you need to have a compatible wallet and select the dollar or satoshi account for sending or receiving.

However, there are certain risks to consider when using Stablesats:

- Similar to the saying "not your keys, not your coins" with exchange platforms, with Stablesats, it's "not your keys, not your shorts". In the event of a platform (Bitcoin Bank) going bankrupt, the collateral and short position may be lost.
- Platforms may automatically close positions, even if they are in latent profit.
- Slippage is the difference between the expected price of a financial transaction and the actual price at which it is executed. Although it is rarely significant, it could result in value losses in cases of high volatility or insufficient liquidity on the exchange platform's market.
- Fees for short positions could increase. Historically, there have been more long positions than short positions on derivatives exchanges. This environment allows short positions to be fee-free. However, this could change in the future and make holding Stablesats subject to fees.

In summary, Stablesats offer a means of holding and using dollars that are exchangeable with anyone using the Lightning Network. The main risk comes from the exchange platform that holds the BTC collateral and short positions.

Therefore, Galoy is working on managing this risk by relying on multiple simultaneous marketplaces in the future, which could be centralized platforms like OKX or decentralized ones like dYdX.

What are the use cases for Stablesats?

Unlike stablecoins like Tether's USDT, Stablesats are not primarily designed as a means of preserving profits.

In reality, Stablesats have been introduced in the Blink wallet, which utilizes the Lightning Network and is specifically designed for everyday use. It targets populations with limited or no access to the traditional banking system. The primary use case for Stablesats, therefore, is for everyday expenses.

Who is behind Galoy?

Co-founded and led by Nicolas Burtey, the startup Galoy brings together a team of 16 individuals, including engineers, designers, data scientists, and educators, with the goal of developing financial solutions based on Bitcoin.

Galoy believes in the importance of the decentralized financial system that Bitcoin can create, as it enables faster, simpler, and more efficient financial inclusion than the traditional banking system, which remains inaccessible to 2 billion unbanked individuals.

Galoy notably created the Blink wallet, which greatly popularized the adoption of Bitcoin in El Salvador, specifically in El Zonte, a small town at the forefront of Bitcoin usage in the country.

The Blink wallet was designed to be user-friendly. Creating a wallet is as simple as using a phone number, and it enables:
      1.  Receiving and sending BTC via the Lightning Network.
      2. Saving contacts for easy satoshi exchanges, with a map listing global points of sale accepting payments with the Blink wallet.
      3. The opportunity to earn satoshis by learning about Bitcoin and answering a few questions.And finally, the ability to transfer dollars via the Lightning Network using Stablesats.
      4. Blink is widely used in what Galoy refers to as "circulating economies," such as Bitcoin Beach in El Salvador, Bitcoin Lake in Guatemala, AmityAge in Honduras, MOTIV NGO in Peru, Praia Bitcoin in Brazil, and EasySats in Namibia.

Conclusion on Galoy's Stablesats

Stablesats offers an innovative approach to creating US dollars on the Bitcoin Lightning Network. Based on a short position on BTC, it presents interesting advantages, especially for those seeking to reduce BTC volatility to safeguard their purchasing power.

The compatibility of Stablesats with the Lightning Network makes them even more efficient than a stablecoin or the dollar itself, thanks to the network's transaction speed and low fees.

With its open-source code, Stablesats changes the paradigm of stablecoins. They are not just another token issued on a blockchain; they are actually BTC. Stablesats serve as a means for individuals to create their own protection against volatility.

However, it is important to remember that Stablesats are not without risks. Like any system based on a trusted third party (in this case, the "Bitcoin Bank"), there is a risk of failure on their part.

Nevertheless, Stablesats offer an interesting solution to replicate the value of the US dollar while remaining accessible and user-friendly. The user experience of the Blink wallet has been designed for everyday use and has been particularly successful.
Source : Galoy