Ratings agency Fitch said in a note on Thursday there may be significant adverse effects for cryptocurrency and digital finance should investors lose faith in stablecoins. Rating agency Fitch said cryptocurrencies and digital finance could see significant negative repercussions if investors lose confidence in stablecoins, with several regulated financial organizations increasing their exposure to the sector over the past few months. This week, Treasury Secretary Janet Yellen warned stablecoins remained vulnerable to disruptions, with some being propped up by assets that may lose value or become illiquid during times of stress.
Using LOSE as a case study, this column shows how algorithmic stablecoins are vulnerable to speculative attacks when a system is not sufficiently collateralized. Stablecoins are vulnerable to an run on the funds backing them, should investors lose faith in the mechanisms put in place to guarantee their stable value. Stablecoins offer a certain level of stability lacking in most cryptocurrencies, making them ineligible to serve as real-world currencies. Additionally, their stability allows for many stablecoins to function like a fiat currency inside of cryptobrokerage.
Since stablecoins purpose is to keep track of a single asset, stablecoins are usually backed by a particular asset to which they are pegged. Most stablecoins claim of being stable has made these once-obscure tokens a mainstay in the cryptocurrency ecosystem. Stablecoins are tokens that are pegged to the value of traditional assets, usually the US dollar, and are a primary means for moving money among cryptocurrency, or for converting balances to fiat money.
Unlike highly volatile cryptocurrencies like bitcoin, the price of stablecoins is not designed to fluctuate. Stablecoins are supposed to be a segment of the crypto market immune from wild swings in value which characterize assets like Bitcoin.
TerraUSD, or UST, is supposed to be a stablecoin–a type of cryptocurrency meant to be tied to a stable asset–that is supposed not to swing in value. The stablecoin TerraUSD is an algorithmic stablecoin, that seeks to maintain a peg of one-to-one with the US dollar, via an algorithm controlling the supply of a related cryptocurrency called LUNA LUNAUSD, -5.26. TerraUSD (known by its ticker symbol UST), one of the few stablecoins designed to keep a $1 market price, has fallen significantly from this benchmark. TerraUSD, though, the stablecoin also purportedly tied to the dollar, continues to sag, sitting at 14 cents, according to data tracker CoinGecko.
A large sell-off in Luna, a sister coin linked to TerraUSD, plunged the USD to its lowest point yet yesterday, 23 cents. By Friday, Tether was trading solidly back to $1, quelling investors fears about possible contagion of the cryptocurrency markets by the failure of troubled stablecoin project Terra. Tether, the biggest stablecoin, which developers claim is backed by U.S. dollars, is trading at $1, having fallen as low as 95 cents Thursday. Article Contents Tether, the biggest stablecoin whose developers say is backed by dollar assets, was also pressured, falling to 95 cents on Thursday, according to CoinMarketCap data, but was back at $1 Friday.
Early Thursday, mounting pressure rocked Tether, the largest stablecoin in the world, which has an $80-billion market cap. Cryptocurrencies were nursing major losses Friday, with Bitcoin barely breaking $30,000 and setting up a record-breaking loss streak following the crash of the so-called stablecoin, TerraUSD. The tumble of TerraUSD, a so-called stablecoin, sent shockwaves across crypto markets. Cryptocurrencies were stable Friday, with Bitcoin BTK22 recovering from its 16-month low following a volatile week that was dominated by the crash in the value of TerraUSD, a so-called stablecoin, TerraUSD, a so-called stablecoin. As the crypto markets have declined, with some users withdrawing significant amounts of UST, investors have largely lost faith in the value of the other cryptocurrency tokens.
In the past few months, developers behind UST also purchased billions of dollars of bitcoins, which further propped up the value of stablecoins. Mati Greenspan, the chief executive officer of Quantum Economics, said that the failure of Terra, an upstart stablecoin project, had shaked the confidence in the cryptocurrency markets of other stablecoins, such as Tether. If investors lost faith in a stablecoins ability to pay out funds at par, as they had previously, they might flee, leading the tokens value to fall significantly below $1.
The loop of repurchasing TerraUSD at $1 and buying Luna tokens fails because investors have lost faith in a simple arbitrage mechanism. When the TerraUSD peg is broken, it causes loss of faith in Terra blockchain and in Luna. One natural resolution is to have TerraUSD backed up entirely with stable collateral, ideally liquid U.S. Dollar reserves, or their stablecoin equivalents, on the Terra blockchain. For instance, if the collateral-to-stablecoin ratio falls below a threshold, then the system requires the liquidation of TerraUSD in order to maintain complete collateralization and stable pegs.
If markets drop, then short-term corporate debt (and those other assets) can rapidly drop in value, making stablecoins tethered to less than full reserves at precisely the time they might be needed the most. The operating company for the other stablecoin, called Tether, says that it has needed assets in Treasury bonds, cash, corporate bonds, and other money market products. The stablecoin USDC could claim to have because USDC is backed by cash or other secure, liquid assets: For each USDC dollar in circulation, Circle, its issuer, says, there is an equivalent dollar in a bank account Circle could wire to someone willing to exchange the digital cash for the real thing. Stablecoin holders could find themselves on the losing end of an old-fashioned bank run, an astonishing fate for a technology that touts itself as being very modern.