UST (Terra) Stablecoin Adoption Critical for the Crypto Ecosystem
Defusing the Crypto TimeBomb and enabling a DeFi future with Terra Stablecoins
Diversifying reliance on centralized stablecoins is vital to minimizing the crypto ecosystem’s most significant long-tail risk. Centralized stablecoins, namely US Tether (USDT), have been shrouded in controversy for years. It’s been referred to by Vitalik Buterin (Ethereum founder) and Jim Cramer (CNBC Mad Money host) as a ticking timebomb.
Additionally, only by adopting decentralized stablecoins can permissionless methods of payment and decentralized finance (DeFi) applications thrive. After all, DeFi applications aren’t genuinely permissionless and immutable if they’re dependent on centralized stablecoins issued by obscure third-party entities.
Importance of Stablecoins
The importance of stablecoins for the crypto market can not be understated. If stablecoins were to disappear overnight, liquidity would dry up, and the entire crypto market would collapse.
Stablecoins allow investors and traders an easy way to manage risks without having to go through the often lengthy and cumbersome process of onboarding and off-ramping to fiat directly. Moreover, it reduces the friction to investing in the altcoin market and DeFi applications by providing a seamless method to move dollar-denominated stablecoins from one platform/exchange to another often within minutes.
There are three primary types of stablecoins: fiat collateralized, crypto overcollateralized, and algorithmic. Currently, fiat-collateralized stablecoins issued by centralized entities dominate the market, with USDT, USDC & BUSD making up ~93% of the entire stablecoin circulating supply and essentially all stablecoin to crypto trading volume. USD Tether (USDT) alone makes up over 57% of stablecoin circulating supply and an incredible ~85–90% of all stablecoin daily trading volume today.
Problem with Centralized Stablecoins
In theory, fiat-collateralized stablecoins issued by centralized third parties are collateralized 1:1 with fiat currency or other cash equivalent assets such as short-term treasury bonds. Hence, the stability of fiat collateralized stablecoins ultimately relies on the market’s belief that the stablecoin is fully backed and would be redeemable 1:1 for a US dollar if the holder demands.
In practice, stablecoins issuers have been somewhat opaque, and it has thus far been unverifiable whether or not they’re all fully backed and redeemable in large quantities. With that said, the market can be blatantly naïve and overly trusting, especially when there is little to no other alternative.
Lack of Transparency
Tether for example has yet to produce a single audit since its inception despite multiple accusations of not being fully backed. This lack of transparency has resulted in numerous run-ins with regulators and has been responsible for causing a great deal of market uncertainty. More recently, Tether has once again come under intense regulatory scrutiny with the US Justice Department announced that Tether executives would face a criminal investigation into bank fraud on July 26th, 2021.
While I could go on at length about Tether’s less-than-ideal history, that’s outside the scope of the topic. Instead, if you are interested, you can check out Coffeezilla’s Youtube video “Exposing Tether — Bitcoin’s Biggest Secret” which does an excellent job explaining the controversy surrounding Tether.
The bottom line is there is no way to verify whether or not USDT is fully backed and redeemable for US dollars if it had a bank run-like scenario.
Furthermore, while the media spotlight has often been on USDT due to its market dominance and questionable history, all centralized stablecoins and private money that isn’t FDIC insured inevitably faces the risk of bank run scenarios. Stablecoins today are analogous to the Free Banking Era of the 19th century when banks issued their own notes. The banknotes were traded at a discount to par value depending on the perceived risk of the issuing bank. The same could happen with stablecoins if doubts of their backing or ability to fulfill redemptions arose. USDT experienced this in April 2017, where its peg broke for nearly three weeks, reaching a discount of ~10% to par value.
Centralization
Furthermore, because USDT is a centralized stablecoin, this means that it’s not immutable nor permissionless. Funds could be reversed, frozen, or confiscated involuntarily, whether due to regulatory pressure, a hack, or Tether’s discretion.
This runs counter to crypto’s ethos of decentralization, immutability, and a permissionless ledger. The reality is there can be no permissionless method of payment or true DeFi if the entire crypto liquidity infrastructure is dependent on a few centralized stablecoin.
If any of this sounds unbelievable and even arguably unacceptable, it should. The crypto ecosystem shouldn’t be reliant on any single entity, never mind Tether, a company surrounded by so much controversy.
Decentralized Stablecoins
Fortunately, there’s an opportunity to move away from the reliance on centralized stablecoins.
Adopting competing alternatives such as US Terra (UST) will improve the resilience of the crypto ecosystem by diversifying dependence on centralized fiat collateralized stablecoins (USD Tether, USD Coin & Binance USD).
Furthermore, ensuring that decentralized stablecoins play a prominent role in the ecosystem is the only way to enable a future where decentralized payment methods and real DeFi applications can succeed.
Algorithmic Stablecoins
The non-collateralized (algorithmic) stablecoin concept was initially coined by Robert Sams in 2014 in his paper, “A Note on Cryptocurrency Stabilisation: Seigniorage Shares.” It proposes a structure where stablecoins could maintain peg stability without collateralization by having another token absorb the price volatility.
Like over-collateralized crypto stablecoins, algorithmic stablecoins such as UST (Terra) are decentralized and fully transparent. However, algorithmic stablecoins have a significant advantage in that it’s far more scalable than over-collateralized stablecoins.
The most popular overcollateralized crypto stablecoin today is Maker DAO’s “DAI”. To mint $1.00 worth of DAI, a minimum collateral deposit requirement of $1.50 has to be maintained to avoid penalties or liquidation of collateral. This requirement of overcollateralizing is extremely capital inefficient and makes overcollateralized stablecoins a less than ideal candidate for mainstream adoption due to scaling limitations.
Why UST (Terra) Stablecoin?
Terra stablecoins maintain their peg through an explicit arbitrage loop against its native token “LUNA.” And its value is backed by the value of the Terra ecosystem rather than asset collateralization. If this concept goes over your head, feel free to check out my video on “Understanding Terra-Luna’s UST Peg” to get an in-depth understanding of how UST’s stabilization mechanism works.
UST (Terra) is the largest decentralized algorithmic stablecoin. There are however other algorithmic stablecoins such as Frax, DefiDollar & Ampleforth, to name a few, but none have garnered significant traction. Algorithmic stablecoins may be the gold standard for stablecoin in the future, but they’re incredibly challenging to get off the ground. The difficulty lies in a chicken and egg problem, where for algorithmic stablecoins to have value, it needs to have a use case, but for it to have utility, it needs to have value.
As Robert Sam said in regards to the many algorithmic stablecoin whitepapers:
“The Seigniorage Share models experiments (Algo stablecoins) today place too much emphasis on the mechanism as if the mechanism alone creates stability. Ultimately the ingredients for stability require an incentive-compatible mechanism, but you also need an ecosystem of usage, meaning organic demand that wants the stablecoin: no mechanism alone is going to bootstrap that.”
- Robert Sams
The success and growth of UST as an algorithmic stablecoin is credited to Terraform Lab’s ability to bootstrap the Terra ecosystem with protocols/applications that have real-world use cases. These protocols/applications include the “Chai payment App,” which processes over $1 billion in transactions per year in South Korea, the “Anchor Protocol,” a savings protocol with over $3.3 Billion in total value locked, and “Mirror Protocol,” a derivatives liquidity protocol with over $1.8 Billion total value locked. All these applications/protocols utilize Terra stablecoins exclusively.
One could say Terra has solved the chicken and egg problem, and the ecosystem has begun to take on a life of its own. In addition to Plylon Protocol, Spectrum Protocol, and Loterra, which were recently launched last quarter, over 60 new third-party projects are currently building new protocols/applications on Terra, further bolstering Terra’s stablecoin use cases.
How Things Stand Today
UST has seen exponential growth over the last year, with currently over 2 billion in circulation. Impressive, however, nonetheless still relatively tiny when compared to the centralized stablecoins today.
Moreover, UST’s circulating supply is almost entirely locked up and used in DeFi applications on the Terra ecosystem (Chai Payment App, Anchor Protocol, Mirror Protocol, Pylon, LoTerra, etc.).
The TerraForm Labs team has thus far looked outwards and focused most of its efforts on implementing use cases for mainstream adoption rather than cater to the crypto markets.
That said, there is no reason why UST couldn’t play a more prominent role in the crypto ecosystem and even become a de facto alternative to centralized stablecoins. It’s decentralized, fully transparent, scalable, and so far has proven to be able to maintain peg stability through extreme market turmoil.
The main barrier to UST becoming a household crypto stablecoin trading pair lies with centralized exchanges where most trading volume happens. Crypto exchanges are essentially the gatekeepers that decide which trading pairs are listed and which are not. However, since exchanges are profit-driven and make markets based on customer demand, I believe the crypto community has considerable influence.
Adoption of UST as a mainstay stablecoin to crypto trading pair is one of the best things that the crypto community can do to minimize the systematic risk posed by centralized stablecoins. If Tether stablecoins is indeed a ticking timebomb, Terra stablecoins is our defusal kit.
As of writing, with exception of Coinbase and Kukoin, there aren’t UST stablecoin to crypto trading pairs offered on any of the other exchanges.
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