For anyone interested or invested in trading the cryptocurrency markets, odds are you’ve come across or used a stablecoin. Trading pairs are quoted using them, brands offer them as rewards, bounty or airdrops, exchanges offer them as yield rewards for staking and more. The importance of this category of cryptocurrency can not be stated more clearly than the metrics behind them.
The stablecoin market capitalization currently sits at over $150 billion, controlling 15.22% of the total cryptocurrency market cap at the time of writing this article. The largest asset in this category, Tether USD (USDT), dominates almost half the entire stablecoin market, controlling a 44.58% share that correlates to a $67.92 billion market cap.
For data and analysis on stablecoins, please refer to DefiLlama.
For an asset to control more than 1/7 of a market’s share, its importance should not be taken into light consideration. Stablecoins have penetrated deeply into the fabric of cryptocurrency trading, staking, farming etc. A popular saying amongst crypto traders highlights the importance these tokens have in the current market:
Keep your funds in bitcoin to acquire more USD in a bull market. Keep your funds in stables to acquire more bitcoin in a bear market. — Anonymous
With such an important standing and role in the crypto ecosystem, why did the stablecoin market witness one of its worst years to date? What problems led to multiple stables losing their pegging to the assets they were tethered to? How are stablecoins viewed now and what is the future of stablecoins in the cryptocurrency market?
We will dive deep into the unstable waters we know as stablecoins, to gain an understanding of what has been happening and why; but first, a light lesson on stablecoins for my uninformed audience.
Stablecoins: What are they?
These are cryptocurrencies that have their values derived from real-world currencies, commodities or instruments which they imitate. Their values are “pegged” to 1 unit of the real currency, commodity or instrument they are imitating. For example, TetherUSD (USDT) imitates the US Dollar and has its price fixed at $1 ( 1 unit of the US Dollar ). Their value is not intended to appreciate as they act as the “digital form” of the real currencies they are tethered to.
Stablecoins are a fundamental pillar in the decentralised ecosystem, created to bring about stability to an often time volatile market. Primarily used as a medium of exchange, a role which most cryptocurrencies cannot play well due to their volatile nature.
Stablecoins are divided into 3 types, based on the asset(s) used to maintain their stability:
- Fiat-collateralized Stablecoins: stablecoins that have reserves of fiat currencies or commodities (rare occasions) such as the US Dollar, that act as collateral assuring the value of the stablecoin.
- Crypto-collateralized Stablecoins: stablecoins are backed by other cryptocurrencies. Due to the volatile nature of cryptocurrencies, these stablecoins are over-collateralized- meaning that the reserves exceed the value of the stablecoin it backs.
- Algorithmic Stablecoins: this type is not backed by a reserve that is collateralized, but is kept stable by controlling its supply by a set algorithm.
Knowing the types of stablecoins and how they are backed will be key to understanding how different stables fell and lost their pegging.
The Depegged Class of 2022
Before I present to you the stablecoins that lost their pegs, I must state that I only do so for education and to increase literacy. This year has been really poor for stablecoins and bitcoin.com put it best:
2022 has been the year of broken stablecoins as a myriad of dollar-pegged crypto assets depegged from their dollar value this year.
TerraClassicUSD, USTC ( formerly TerraUSD, UST ) — Algorithmic Stablecoin
There was no other contender for the coveted top spot. Terraform Labs dropped the ball by allowing a very promising decentralised project to turn into an international financial fiasco. The domino effect that followed the fall of LUNA and UST is still felt to this day.
UST was a stablecoin that had its value of 1UST=$1 maintained through a “mint or burn” mechanism. This mechanism is a two-coin system That uses LUNA (Terra’s native cryptocurrency) and UST (Terra’s stablecoin).
This mechanism is well used today as many cryptocurrency projects look to find new and innovative ways of creating a scarcity of their token. This mechanism requires computer programs or smart contracts to regulate the amount of a token in circulation based on the fundamental principle of demand and supply.
“When there is high demand for a product/service, its price generally rises due to scarcity of a well sought after item in the market. When there is high supply, the price of the product/service generally falls due to surplus of the item in the market without the consumer need to match.”
In the case of UST, an increase in the demand for it would see its price rise above $1 (1UST>$1). To maintain its stable price of $1, $1 of UST would be minted. To mint $1 of UST, $1 of LUNA will be burned, thus algorithmically tethering UST to its sister coin LUNA.
Minting $1 of UST leads to an increase in the supply and ultimately lowers the price. At the same time, it “burns” $1 of LUNA. When the UST demand is too low, users can mint LUNA to reduce the supply of UST and increase its value back to $1. By minting LUNA, an equal value of UST is burned.
What Happened?
To summarise what happened — Terra imploded, literally.
The death of UST is, by most crypto traders, attributed to a George Soros-esque attack. It took 2 days, May 7 to May 9 this year, to destroy the Terra ecosystem. UST plunged to $0.35 on May 9, while LUNA fell to less than $0.1 three days later.
Their demise caused the market to become unstable, with fear gripping the majority of traders. The cost of bitcoin dropped to $26,000, a 60% decline from its peak in November 2021, while the value of ether, the second-largest cryptocurrency, dropped by 30%. One of the biggest bitcoin exchanges, Coinbase, posted a Q1 loss of $430 million.
Authorities in South Korea wanted to examine cryptocurrency exchanges more carefully because it was believed that about 280,000 of their residents had been hurt by the sudden drop in UST and LUNA.
Many institutional investors lost huge parts of their portfolios to the Terra crumble, with Three Arrows Capital, Celsius Network and Voyager Digital filing for bankruptcy due to their exposure to the Terra ecosystem. The collapse seemed to have cost Terra-backer Hashed, a well-known venture firm based in Seoul, South Korea, more than $3.5 billion.
You can read the coin desk article for a detailed timeline summary of the Fall Of Terra.
HUSD — Fiat-collateralized Stablecoin
According to Messari, HUSD is a fiat-collateralized stablecoin that offers the advantages of transacting with blockchain-based assets while mitigating price risk. The HUSD are issued as ERC-20 tokens on the Ethereum blockchain and are collateralized 1:1 by USD held in Paxos-owned US bank accounts.
HUSD was created by Huobi Global, a top-tier centralized exchange. In a sense, you can say that they created an equivalent of Binance’s BUSD, though not as successful.
HUSD lost its dollar peg on august 19, plunging as low as 0.82 before recovering to the low 0.90s, eventually making a full recovery to $1. It is at a price of $0.995, as at the time of writing.
The decision to close market maker accounts in numerous locations to adhere to regulations was what led to the depeg. Huobi claimed that the HUSD lost its dollar peg as a result of a liquidity issue brought on by the disparity in regional banking hours.
Though it didn’t produce the sparks we saw UST make earlier in the year, it is still worthy to note as a stablecoin from a very reputable exchange.
Alpaca USD (AUSD) — Crypto-collateralized Stablecoin
Five days before HUSD fell below its $1 peg, Polkadot-based stablecoin AUSD lost its peg. Its value went down to an all-time low of around $0.006383. AUSD’s price had bounced back to the $0.95 range, but then it quickly slipped to $0.01165.
The depeg happened as a result of an exploit on Alpaca Network, which saw hackers print 1.2 billion $AUSD. The price, as when recorded, on September 19, 2022, was trading at $0.966
Other notable mentions that also fell below the $1 peg this year:
- Waves backed USDN, an algorithmic stablecoin.
- DEI, a complex algorithmic stablecoin in the DEUS ecosystem.
- USDD, Tron DAO’s algorithmic stablecoin.
- Kava Network’s USDX, a crypto-collateralized stablecoin.
- Abracadabra’s Magic Internet Money (MIM).
Now, for clarity’s sake, a depegged stablecoin can also be ABOVE the value it is pegged to. I have included a visual representation of the most depegged stablecoins on the rise, as well as on the decline to date.
The way forward
It is common knowledge that an appraisal must be undertaken on the stablecoin market. A move away from complex algorithms that leave the door open to hackers and exploits will do more harm than good. Fiat-collateralized stablecoins enjoy more stability because their backing comes from assets used in society and for real life. take BinanceUSD (BUSD) as an example, backed by real US Dollars that are in an audited account, BUSD has remained one of the most stable stablecoins.
The top stables are fiat-collateralized, proving this economic rhetoric correct:
For something to be given monetary value, the users must believe it has such value and is transferable. Anything purely backed by computer codes, without actual money behind it will simply fail. Computers don’t spend money, humans do, so computers cannot decide what is or is not money, that’s a human job.
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