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One of the reasons stablecoins stand out in the crypto space is that, unlike meme tokens and other purely speculative assets, they have a very clear use. By always remaining equal in value to a designated fiat currency—we’ll stick to the US dollar for convenience—they provide investors with an ostensible safe haven from market volatility.
Cryptocurrencies are having a pretty rough year, and while many are looking to stablecoins as a potential solution to the current volatility, the world is learning that stablecoins don’t guarantee stability. Despite the use case for stablecoins being fairly straightforward, how the dollar peg is actually achieved and maintained is a much more complicated matter. Some stablecoins like USDC and Tether (USDT) are backed by cash reserves that have a value equivalent to the number of tokens in circulation. Others like MakerDAO’s DAI and Abracadabra’s Magic Internet Money (MIM) rely on an over-collateralized store of other cryptocurrencies. And then there are “algorithmic stablecoins” which claim to utilize some combination of crypto reserves, smart contract technologies, and token pairings.
The stablecoin space is constantly developing; for example, Congress is currently working on a stablecoin bill intended to help non-banks issue government-regulated and approved stablecoins. In this blog, we’ll look at some of the challenges in the crypto and stablecoin space, and we'll examine how boosting transparency can rebuild trust and enable meaningful regulations of the broader crypto industry.
We can’t talk about stablecoins without mentioning the TerraUSD (UST) elephant in the room. TerraUSD was the brainchild of a young, eccentric developer named Do Kwon, and former algorithmic counterpart to the Terra ecosystem’s native token, Luna. UST was pegged to the price and trading activity of Luna, as well as the promise of sky-high interest rates for those willing to lock their assets on the popular lending platform, Anchor. We’ll spare you the technical breakdown of UST’s flaws—author Muyao Shen provides an eloquent explanation in an article for Bloomberg—but as you likely already know, the TerraUSD experiment did not end well.
In late May, as selling pressure crunched down on the broader crypto market due to a perfect storm of macroeconomic and geopolitical factors, investors began dumping large amounts of Luna, crashing the token’s price into oblivion. In a matter of days, Luna went from being valued at over $100 per token to only fractions of a penny. And because of UST’s algorithmic dependence on the token to maintain its dollar peg, the stablecoin came crashing down with it.
The event erased close to $60 billion in value from the crypto market, obliterated the life savings of many investors, and triggered what is arguably the biggest erosion of trust in stablecoins and cryptocurrency since the industry’s inception. But unfortunately, this was only the beginning.
Since Terra’s implosion, most investors have been forced to accept their losses and hope that Do Kwon will be held responsible. While any wrongdoing by Do Kwon or Terraform Labs will need to be decided by a court (he continues to maintain his innocence), the industry is currently more focused on a newer development in Luna and UST’s wake.
Three Arrows Capital (3AC), a crypto hedge fund that once managed $10 billion in leveraged assets, but has since gone insolvent, filed for Chapter 15 bankruptcy, and been forced to liquidate its holdings. And according to creditors, the fund’s Singapore office has recently been abandoned and its founders have apparently gone missing. And then there’s Voyager Digital, a Canada-based centralized exchange and publicly-traded company on the Toronto stock exchange, that also recently froze user withdrawals citing “extreme market conditions,” shortly before filing for bankruptcy and hanging users out to dry.
In early June, thousands of users logged into their accounts on the popular crypto lending platform, Celsius, to find that their ability to withdraw funds had been revoked. Celsius, much like Anchor, promised its users exorbitant returns (up to nearly 20%) for depositing on their platform. At the time of writing, users still have not regained access to their funds, and have received little guidance from the company as to when, if ever, the issue will be resolved.
So how do stablecoins fit into this equation? Beyond TerraUSD’s collapse, it turns out the world’s largest stablecoin Tether (USDT) was one of the first investors in the Celsius network and briefly lost its peg after Celsius moved to freeze withdrawals. This isn’t the first time that Tether has wobbled, either, and regulators and analysts alike are concerned that a sustained unraveling of USDT could result in damages that would make the Terra situation look mild.
Moreover, it’s a matter of trust and ownership. Before the downfall of Voyager and Celsius, centralized exchanges and lending platforms were considered by many to be relatively secure places to store and trade digital assets. Now, even the security of some of the largest exchanges in the world are being brought into question. If the dominoes continue to fall, there is a sense in which the function of stablecoins as a shield against volatility could become significantly less meaningful.
To ease fear around stablecoins, we must promote transparency that leads to trust and meaningful regulation of the crypto industry and learn more about how popular stablecoins are managed. Late last week, Paxos Trust took a significant first step in this direction, when the fund disclosed all assets that it holds to maintain the peg of Binance USD, the third-largest stablecoin in circulation.
Paxos showing its cards–including the unique identification numbers of each Treasury bill in its reserves–is an incredibly rare move for a stablecoin provider. At the end of the day, some basic transparency from larger players in the space could not only lead to less intrusive regulatory oversight, but also to increased confidence among investors at a time when they need it the most.