Stablecoins are an important part of the crypto ecosystem. So when they lose their ‘stability’, it can cause many things to go wrong.
Offering the benefits of digital assets while maintaining stable value, stable coins have become a popular instrument in the cryptocurrency market. However, the stability of these tokens cannot be fully guaranteed. Several stablecoins have been de-pegged from their underlying assets, causing concern in the crypto community.
Stablecoins are digital tokens designed to maintain a stable value by being tied to an underlying asset. A fiat currency, commodity, or cryptocurrency often underpins a stablecoin. They are essential to the crypto ecosystem, bridging traditional finance and digital assets like bitcoin. Their intended stability and low volatility make them an attractive investment option and a haven during market turbulence.
The most popular stablecoins include Tether (USDT), USD Coin (USDC), and DAI. At press time, four of the top twenty cryptocurrencies by market cap are stable coins, according to CoinMarketCap.
Stable Coins and Depegging
However, recent instances of stablecoins de-pegging their underlying assets have raised concerns about their credibility.
Earlier this month, the popular stablecoin USDC fell from its nominal value of 1 USD to a low of 87 cents. The Silicon Valley Bank (SVB) crisis accelerated the decline. USDC Issuers Circle revealed that SVB holds $3.3 billion or approximately 8.2% of its total USDC reserves. This led to a crisis of confidence in the value of the asset.
Circle later announced that the reserve risk was “removed” after the funds became available a few days later.
USDC and USDT are both reserve-backed stablecoins. In the case of USDC, it is backed by cash and short-dated US government bonds.
Funds from traditional currency, cash equivalents, and third-party loans back USDT. When these reserves are threatened, even temporarily, the coin’s price may deviate from its stable value.
The de-pegging phenomenon has also had an impact on the wider crypto market. Dapping presents a unique threat to DeFi platforms whose operations depend on the stability of these tokens.
“So 90% of DeFi is dependent on USDC alone,” said Paolo Ardoino, CTO of Tether and Bitfinex. “I think this is a teachable moment. If you’re in a decentralized industry, and you have a single point of failure, that’s not the best thing to do.”
“If you have a liquidity pool that provides loans, and you assume that stablecoins are always one-to-one. And if they’re down 13%, it could cause crazy problems for the liquidity pool. . So luckily, nothing dramatic happened. But I think we could be seeing the end of DeFi.”
Terra: The Great Depegging
The most infamous decline of a stablecoin happened last spring with TeraUSD (UST). The stablecoin promised to maintain a value of $1 by using its sister coin Luna to support the peg. However, in May 2022, a bank run-like event led to the collapse of the Terra stablecoin and the Luna token, shattering investor confidence.
Algorithmic stablecoins like UST maintain price stability by controlling supply and demand, but large fluctuations in buying and selling can make the coin volatile. The increased supply of Luna on the crypto markets and the de-pegging of TeraUSD made Luna practically worthless, and Luna and TeraUSD were subsequently delisted from most major crypto exchanges around the world. The saga erased tens of billions of value from the crypto ecosystem in a matter of days.
How should governments and central banks react?
To address the de-pegging issue, stablecoin issuers have taken several steps to restore trust in their tokens. They have increased transparency, improved collateral management, and implemented stricter oversight measures.
However, technical and regulatory solutions are needed to prevent future de-pegging incidents. For example, algorithmic stable coins, which use smart contracts to adjust the supply of tokens to maintain their value, may be less susceptible to de-pegging. Stable coins backed by a basket of assets or central bank digital currencies (CBDCs) may also provide a more stable option.
According to Ardoino, there are not enough regulations in place to guarantee the confidence and safety of investors. “I think regulators should provide a little more guidance on how stablecoins work and what should be in their reserves. To me, this is extremely important because there are no major jurisdictions right now that provide guidance on stablecoin reserves. ,” he explained.
Ardoino believes that despite the rise of central bank digital currencies (CBDCs), there is still ample reason to believe that stablecoins are here to stay. For one, central banks are “scared,” he said. “Because once you launch it, you don’t know the effects it will have on the economy. It could be devastating. You don’t know how people will react, how it will change the banking industry, and how it will affect businesses. How will it change?
it’s all about education
Looking ahead, the de-pegging phenomenon is likely to have long-term effects on the perception and adoption of stablecoins. New stablecoin projects may enter the market, offering innovative solutions to address existing challenges. But as long as they don’t live up to their promise of stability, none of that matters to them.
What does Ardoino think we should do next? “It’s all about education, isn’t it? I also think you should always try not to get FOMO into the markets because someone tweeted something on Twitter. Before you start speculating in the markets it’s important to know some basics.” It is important to understand and learn. Therefore, I would always suggest people to first read why bitcoin is important in our industry, and then start thinking about whether you want to speculate or not.
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