From Algorithmic Stablecoin Disaster to Necessary Evil CBDCs
Authors:
Ahmet F. Aysan
Professor Hamad Bin Khalifa University, Qatar Foundation & Research Associate, the University College London Centre for Blockchain Technologies (UCL CBT)
Ahmet S. Tunali
Middle East Technical University
After several collapses, many believe that algorithmic stablecoins are doomed to fail. Luna and UST had appeared to beat this ill fate, until they also failed. Hope has turned to fear for stablecoins, and that fear could be the catalyst for CBDCs.
Usually, stablecoins like Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) are backed by cash, commercial papers, government and corporate bonds, and cryptocurrencies. However, algorithmic stablecoins like Luna’s UST or Waves’s USDN have no collateral. Instead, they stabilize stablecoins with their main cryptocurrency. In this case, if the UST depegs from its 1:1 ratio, people can exchange their UST for 1 dollar equivalent of Luna, which repegs the UST to 1 dollar. Luna supply automatically changes by burning and minting new coins according to demand.
Compared to other algorithmic stablecoins, UST had been very successful, and both UST and Luna were in the top 10 in May 2022 in terms of market cap. When the possibility of collapse started to be clearly discernible, Do Kwon backed UST like a typical stablecoin, having sold 3 billion dollars’ worth of bitcoin and having planned to increase it up to 10 billion dollars. However, the spreading rumour was enough to scare the investor, and the depeg took place. When this depeg happened, the demand to exchange UST for Luna, equivalent to 1 dollar, increased due to the underlying mechanism mentioned above, and the supply of Luna increased from 350 million to 6 billion in just two days due to extreme demand resulting from the depeg. Hence, 50 billion dollars’ worth of cryptocurrency evaporated in a matter of days.
As explored in Polat et al. (2021), fear in social media dramatically impacts crypto prices. Fear in crypto reached its plateau due to the COVID-19 outbreak and China Mining Ban levels (1)(2). The Luna crash caused cryptocurrencies to drop, USDT was de-pegged for a short time, and the stablecoin issue started to occupy the agenda.
Stablecoins have become a gigantic business in recent years. In 2018, while bitcoin was $20,000, stablecoins were valued at only 2 billion dollars. However, today, when bitcoin comes to 20 thousand dollars, stablecoins have a market share of 15% in the crypto market with a total market cap of 150 billion dollars, according to Coinmarketcap. The fundamental reason for this is the fear in the cryptocurrency market, yet the trust developed for the stablecoins. However, this trust is now shaken by Luna and UST’s failure, and the outlook for stablecoins is even shadier.
Since the stablecoin market cap is currently 150-billion-dollar, financial authorities keep closely monitoring this industry and plan to step in with Central Bank Digital Currencies (CBDCs). Currently, they have a reason more than ever before. After the Luna collapse, Treasury Secretary Janet Yellen stated that this shows the danger of crypto, provided a glimpse into CBDC (3), and renewed the call for stablecoin regulation (4). Similarly, SEC Chair Gary Gensler believes that other cryptocurrencies follow Luna’s path as well (5). While CBDCs seem to hurt crypto’s decentralization, most current stablecoins are not decentralized to begin with. Besides, Federal Reserve Vice Chairwoman Lael Brainard thinks even stablecoins and CBDC could coexist in the future. Thus, CBDC could be a necessary evil as the increase in regulations will attract big players to the market (6). Furthermore, FED Chairman Powell aired the words, “CBDC could help maintain the dollar’s international standing” (7). Hence, it can be a win-win situation for investors and US financial institutions.
References
1. Polat, A. Y., Aysan, A. F., Tekin, H., & Tunali, A. S. (2021). Bitcoin-specific fear sentiment matters in the COVID-19 outbreak. Studies in Economics and Finance. https://www.emerald.com/insight/content/doi/10.1108/SEF-02-2021-0080/full/html
2. https://alternative.me/crypto/fear-and-greed-index/
6. https://beincrypto.com/federal-vice-chair-testifies-to-cbdc-stablecoin-risks/
7.https://www.federalreserve.gov/newsevents/speech/powell20220617a.htm
