How Stable Are Stablecoins, Really? | The Motley Fool
Recent events in the cryptocurrency industry may have made you doubt the usefulness of so-called stablecoins.
Of course, it’s handy to keep a digital coin that can replace the US dollar (or other major global currency) as needed. A trading system designed to handle blockchain-based cryptocurrencies should work best using a crypto-like replacement for regular currencies, so it makes sense that most of the major stablecoins were created and used by the most world’s leading cryptocurrency trading services.
But this is only true as long as the stablecoins are stable. When one of these dollar surrogates loses its connection to the currency to which it is supposed to be firmly pegged, the associated trading system can quickly fail.
So how stable are these digital assets, really?
How smooth can a stablecoin chart be?
A stablecoin pegged to the US dollar should always be worth around $1. The actual token price may vary quite a bit in reaction to changing market conditions, and actions that keep it close to its target price may not always have the desired effect right away. So if you look at the six-month price charts for three of the most important stablecoins over a recent six-month period, you won’t see a perfectly straight line at $1.00 per token – but the coins shouldn’t. get away from that either.
During this period, none of the three stablecoins on the chart moved more than 1.1% away from their perfect target price. Attached (USDT 0.12%) remained particularly faithful to its design objectives, while the TerraUSD (UST -8.94%) and BinanceUSD (BUSD 0.15%)had slightly more pointed tips. All things considered, however, they all earned their stablecoin monikers, and they served their functional purpose as it was designed.
But last week, TerraUSD slipped away from its target price of $1. In just two days, the stablecoin dropped to $0.37 per token. In this context, the earlier squiggles in the chart look like forgettable rounding errors:
What’s wrong with TerraUSD?
Terra is different from most of its stable peers. Tether and Binance USD are backed by real cash and cash equivalents.
The market value of all existing Binance USD tokens is money in a bank account controlled by Paxos Trust. This cash balance always corresponds to the market value of the token and the corresponding values are published at the end of each month. On March 31, the total value of Binance USD tokens in circulation was $17.5 billion, and the Paxos account held that same amount in hard cash.
Tether uses a more fluid collection of traditional assets to secure its dollar-based stablecoin. Most of these reserves are made up of treasury bills, certificates of deposit and cash deposits. There are also a handful of small holdings of precious metals, cryptocurrencies, and secured loans. But the principle is the same as Binance USD, and Tether Holdings always maintains enough reserves to cover the actual market value of the stablecoins in circulation. As of Friday afternoon, that meant $78.7 billion in market value backed by $78.7 billion in miscellaneous assets.
TerraUSD does not work like that. Instead, the value of the stablecoin is controlled by minting or burning tokens from the Earth (LUNA 176.76%) cryptocurrency. This system was designed to scale very quickly, and value-protecting transactions are executed by smart contracts on the Terra network.
This algorithmic stablecoin used to work great – until it no longer did.
On May 9, TerraUSD trading volumes began to spike and the system began to struggle to burn enough Terra tokens. Soon, the Terra cryptocurrency was also losing value at a terrifying rate. Terra went from $60 per token on Tuesday morning to $0.0001 per token on Friday afternoon. This cryptocurrency is no longer strong enough to support a large stablecoin, so the whole two-token system fails.
Could this happen to other stablecoins?
TerraUSD is fundamentally different from most of its peers. Algorithmic stablecoins are a rare breed, and this event will make future stablecoin designers think twice before going down this path.
To be clear, TerraUSD came with some unique benefits. For example, the coin offered extremely high annual interest rates of nearly 20% on TerraUSD tokens that could be borrowed by investors in need of dollar-like capital. But if it sounds too good to be true, maybe it wasn’t meant to be.
Future stablecoin designers will look to TerraUSD as an example of what not to do. But cash-backed stablecoins still look solid. It is also possible that the TerraUSD disaster could have been avoided if the developers had given some parameters more conservative values.
That said, regulators and lawmakers will likely look to TerraUSD’s collapse when designing legal frameworks for cryptocurrencies in general. So, crypto investors will feel the ripple effects of this stablecoin crash for years to come.
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