Nov 21, 2022
How stable are Stablecoins during a market crash
Cryptocurrency markets were already in a bear market before the collapse (and Chapter 11 Bankruptcy filing) of FTX exchange, their trading and investment arm Alameda Research, and the 130+ affiliated entities.
The FTX collapse and all the ongoing social and economic contagion has resulted in a mass exodus out of traditional cryptocurrency assets and into Stablecoin assets, and mass exits from cryptocurrency markets altogether. This ‘flight to safety’ is testing many exchanges as well as Stablecoins.
Amid this market turmoil, there have been numerous concerns raised regarding Fiat-Collateralised Stablecoins discussed on social media, by industry insiders, and by investor groups — all centered around which is the safest Stablecoin?
Fiat-Collateralised Stablecoins are digital assets which are pegged to the underlying fiat currency (typically USD) and are (in theory) backed at least 1:1 by the underlying fiat currency or equivalent liquid cash assets.
These concerns include:
- Can we really trust the quality and accuracy of the collateral audits;
- How liquid are the Stablecoins during periods of high redemption volumes;
- With fresh memories of the Terra Luna UST Algorithmic Stablecoin collapse, where are the technical and smart contract issues in fiat backed Stablecoins;
- If Fiat-backed Stablecoins are truly 1:1 liquid, is there a real risk of depegging?
- There is an unlikely, but real, potential for exchanges to be blacklisted at request of law enforcement and political influence — how safe are customers’ assets on those exchanges; and
- With tightening focus on KYC requirements by regulators, will investors be able to freely redeem Stablecoins for fiat.
As is often the case in cryptocurrency markets — The mere perception of risk associated with any of these concerns can also create a self-fulfilling prophecy, resulting in a Stablecoin bank run.
To believe that Stablecoins won’t experience some level of failure, given the failure of so many fiat currencies in history, I think is naive. Particularly as the failure of fiat currencies has traditionally been at the influence of governments and their intermediaries; both domestic and internationally. Cryptocurrencies also face similar influences from regulators and governments.
The purpose of this short article is to review how stable Fiat-Collateralized Stablecoins are and identify which one carries the least risk.
If you’re interested in jumping down the rabbit hole of Stablecoins, I highly recommend that you read The State of Stablecoins 2019: Hype vs. Reality in the Race for Stable, Global, Digital Money by George Samman.
As an aside — In relation to the risk associated with leaving custody of your digital assets with an Exchange or custodian, my only comment is to recite the long-standing crypto mantra:
‘Not your keys. Not your crypto.’
NOT ALL STABLECOINS ARE CREATED EQUAL
The purpose of a Stablecoin is to provide a stable store of value, a unit of account, and a means of exchange.
There are currently four categories of Stablecoins:
- Fiat-Collateralized Stablecoin
- Asset-Collateralized Stablecoin
- Basket of Cryptocurrency-Collateralized Stablecoin
- Algorithmic Stablecoins
The focus of this article is Fiat-Collateralized Stablecoins — specifically USDT, USDC, and BUSD.
According to Coingecko, as of 17 November 2022, the combined market capitalization of all noted USD denominated Stablecoins (31 of them) was $144 Billion USD. The three largest Stablecoins, USDT, USDC, and BUSD combined represent approximately 92.3% of this Stablecoin market, and these three Stablecoins alone make up approximately 15% of the total cryptocurrency market cap of $883 Billion USD.
Fiat-Collateralized Stablecoins
For Fiat-Collateralized Stablecoins to operate as designed they need to ensure that they are fully/over collateralized and liquid.
To ensure that Stablecoins are collateralized 1:1, the issuing entities need to provide credible, transparent, and regular third-party auditing that verifies the asset reserves that back such Stablecoins. According to Department of Financial Services NY Virtual Currency Guidance, “auditing should be carried out at least once per month by an independent Certified Public Accountant (“CPA”) licensed in the United States and applying the attestation standards of the American Institute of Certified Public Accountants.”
*Trust in auditors is paramount for Fiat-Collateralized Stablecoins. Tether has engaged 6 different auditors since 2017, has also been fined directly for publishing false reserve data and most recently their previous accounting firm was fined
Collateral Observations:
Not all collateral is equal. Some collateral is less liquid than others, and valuations of stated collateral may change based on the underlying assets values and costs of converting it to cash.
For example:
- USDT collateral incorporates Secured Loans (9%) and Other Investments (4%) with unknown details on their maturity details or their underlying security. USDT also lists Corporate Bonds and Precious Metals (4.6%) in their audited reports.
- The USDT audit shows only $39,678,465,980 (58.3%) in US Treasuries.
- By comparison USDC and BUSD have 100% of their collateral with the US Treasury Department as Bonds and also strong Cash Deposits.
When comparing both quality and liquidity of collateralized assets as stated by Stablecoin auditors, USDC and BUSD are the strongest.
Decentralization
It’s important to note that unlike other cryptocurrencies that strive for decentralization, Fiat-Collateralized Stablecoins are centralized. The businesses behind these Stablecoins are storing their USD funds and related assets within the traditional centralized financial system and with traditional financial institutions. This comes with all the drawbacks of centralization. There is a single point of failure: if the accounts are compromised in any way; be it by government intervention, or a corrupt intermediary, the ability to redeem Stablecoins can be compromised and 1:1 collateralization reduced or eliminated altogether. We do not have explicit details on the Stablecoins’ governance practices and policies to really understand their risk mitigation procedures when it comes to their underlying reliance on the centralised traditional finance world.
This centralization element also impacts control over the distribution of Stablecoins, as many addresses have been blacklisted at the request and influence of various law enforcement and regulatory agencies.
When an address is blacklisted, it can no longer receive the Stablecoin asset, and none of the Stablecoins owned by the address can be transferred on-chain.
On 10 July 2020 USDC first blacklisted an Ethereum address (Jake Chervinsky), general counsel to Compound tweeted that “blacklisting has gone from a hypothetical concern to a real risk.”
According to Dune Analytics there are currently:
- USDT: 809 banned addresses, stopping 433,863,585 USDT being distributed
- USDC: 150 banned addresses, stopping 7,024,484 USDC being distributed
- BUSD: 2 banned address, stopping 871,219 BUSD being distributed
To date, no major exchanges have had their addresses blacklisted, however, it is a concern that has been raised amongst several investor groups when researching this article.
Conclusions
The premise of this article was about assessing the high-level fundamentals of Stablecoin stability, in a time of high unprecedented risk. Be it another Black Swan type event, or continual pressure mounting from growing contagion resulting from Terra Luna and FTX.
My preference in an ideal world is for a Fiat-Collateralised Stablecoin that has credible liquid cash and cash equivalent reserves, which are regularly audited by high-quality independent third parties, with transparent and published financial information and governance information.
Whilst USDT remains the dominant and used Stablecoin, both by circulating supply (market cap) and daily traded volume, I have refreshed concerns over their liquidity, the quality of their collateralization in addition to continual concerns over the quality of their audited figures.
That leaves USDC and BUSD
According to Coingecko, over the past 60 days, 22 Sept — 20 November, USDC average daily traded volume was 3.84B, which was only 25% of BSUD 14.95B over the same period.
Of daily trading volume, Binance accounts for 42% of all BUSD transactions with 3.4 billion in daily volume. Important to note that BUSD is only available on 31 exchanges.
Whether using USDC or BUSD, what is most important is to understand the liquidity of each Stablecoin on your crypto exchange.
Coinbase, the largest crypto exchange in North America, do not accept BUSD
Case for USDC: Coinbase and most exchanges
If Coinbase is the crypto exchange you use to convert fiat to/from Stablecoins, the USDC is the preferred choice, as BUSD is not accepted and USDT carries greater risk than USDC.
Binance, the largest crypto exchange in the world accepts USDT, USDC and BUSD. However, they auto-convert USDC to BUSD for trading on their platform. As per their announcement on 22 September 2022 “ In order to enhance liquidity and capital-efficiency for users, Binance is introducing BUSD Auto- Conversion for users’ existing balances and new deposits of USDC, USDP and TUSD stablecoins at a 1:1 ratio. This will not affect users’ choice of withdrawal: users will continue to be able to withdraw funds in USDC.”
Case for BUSD: Binance
If Binance is the crypto exchange you use to convert fiat to/from Stablecoins,
Given the liquidity of BUSD on the Binance, and the fact that Binance auto-convert USDC, and other Stablecoins, BUSD becomes a better choice.
Really interested in your thoughts. Please share them in the comments.
