Gimme a Brick · Jul 4, 2022 · 4 min read
With all the recent news surrounding the crash of certain stablecoins, you might have found yourself wondering what all the commotion is about. You may have heard about the recent collapse of the stablecoins TerraUSD (UST) and Deus Finance’s DEI. Technically, these coins weren’t supposed to collapse and that is why there has been a disturbance in the crypto world. So, what are these coins anyway and why are they so popular? Why would the collapse of a stablecoin be such a big deal? Let’s take a look at a few facts about stablecoins that might be useful to know and might help paint a clearer picture about the current situation.
I: Defining stablecoins
So what is a stablecoin?! A stablecoin is a cryptocurrency with a value that is pegged or tied to a “stable”, outside asset like another currency (e.g. US dollar), commodity (e.g. gold) or financial instrument. Pegging the coin to a reserve asset stabilises the price. For example, USD Coin (USDC) is a stablecoin that is pegged at and costs US$1.00. You can redeem 1 of these coins for US$1.00, giving it a stable price. The reason for creating stablecoins was to help manage digital asset volatility by linking the coins to more stable assets. This high volatility is seen with unpegged cryptocurrencies like Bitcoin (BTC), making investments less suitable for broader use in transactions.
…not all stablecoins are always stable
Stablecoins have also been shown to be very useful for money transfers. Transfers of cryptocurrencies like Bitcoin or Ethereum can sometimes be slow or have high fees but because stablecoins are stable, they are able to move faster and cheaper. Like blockchain, the transfer system of stablecoins is overall better than traditional banking systems. However, as we’ve seen, not all stablecoins are always stable.
Differentiated by how they are backed, there are currently 4 main types of stablecoins,:
- Fiat-backed stablecoins: These stablecoins are backed by fiat currency such as Euro, GBP or the US Dollar. They have a 1:1 ration backing, implying that one stablecoin would be equal to one unit of currency of (e.g.) a dollar or a Euro. Some of the most commonly used fiat-backed stablecoins are Tether (USDT), USD Coin (USDC), Paxos Standard (PAX), TrueUSD (TUSD) and Binance USD (BUSD).
- Commodity-backed stablecoins: These stablecoins are backed and stabilised by hard assets such as real estate or precious metals, with gold being the most commonly used asset to collateralise. Some of the most commonly used commodity-backed stablecoins are Tether Gold (XAUT), Paxos Gold (PAXG), Digix Gold Tokens (DGX), GCoin (XGC) and Darico (DEC).
- Crypto-backed stablecoins: These stablecoins are backed by other cryptocurrency as collateral. This process employs smart contracts instead of relying on a central issuer. Some of the most commonly used crypto-backed stablecoins: Maker Dai (DAI), Synthetix (sUSD) and Reserve tokens (RSV).
- Algo-based stablecoins: These stablecoins are not backed by fiat, commodity or crypto but are pegged to their prices by using algorithms and smart contracts to achieve price stability. They do not have any associated collateral. TerraUSD (UST) is an example of an algorithmic stablecoin gone wrong. Some other algo-backed stablecoins are RAI, FEI and FRAX.
With other cryptocurrencies being noticeably volatile and unpredictable, stablecoins became popular because they seemed sensible and stable, as the name implied. After the crash of two popular stablecoins, however, it is getting harder to prove this. At the moment, there isn’t a lot of concrete regulation surrounding stablecoins yet. Many countries are currently developing regulations and laws to monitor this cryptocurrency but in the meantime, as one can imagine, there are a few risks. Aside from regulatory uncertainty, there are also risks relating to cybersecurity and the algorithms being used to stabilise the coins.
…regulation and solid guidelines are absolutely necessary and needed
Some say algorithmic-backed stablecoins are on the way out since the TerraUSD collapse. On May 9, 2022, TerraUSD, which should always have stayed at $1, fell to 35 cents. By June 17, 2022, the once $18-billion algorithmic stablecoin, was worth $0.006911. Investors and people who had their money tied up in the cryptocurrency had lost more than 94% of the value of their holdings. After this crash plus the collapse of DEI soon after, it has become clear that regulation and solid guidelines are absolutely necessary and needed in order to protect consumers and ban excessively risky practices. Until then, it would be wise for interested parties to do thorough research before investing in stablecoins, other cryptocurrencies or other financial investments. Follow us to learn more and keep up to date with crypto-related info.
Author: Lorraine Tashjian