Stability - the strength to stand and endure. Stablecoins, supposedly stable, were anything but that in the recent weeks in crypto. From the destruction of Terra Luna and its native stablecoin UST, to Tether momentarily losing its peg, crypto investors are now reassessing their stablecoin’s strength and endurance for the impending bear market. Fear and panic has swept through the entire crypto markets. Many are considering moving back into cash for safety and absorbing the 8.3% inflation (potentially much higher). Crypto users hold stablecoins because they offer yield and utility on different protocols and money markets in crypto. Stablecoins are pegged to the U.S. dollar, so 1 stablecoin is worth 1 USD. Users are able to lend/borrow and receive yield for their stablecoins. Your traditional commercial savings account only offers you 0.05% apy, a protocol like (Compound) offers a substantially higher apy on your stablecoins. Furthermore, stablecoins enable quick access for trades and liquidity for users on-chain. If you are in cash, you have to wait for the bank to process your money which can take several days. The crypto market moves fast, having your cash in stablecoins and ready to deploy allows you to take advantage of many opportunities the market has to offer. The importance of stablecoins cannot be denied but many are questioning the risk that is associated with holding these different coins.
The crypto ecosystem has come a long way and has produced many captivating innovations, stablecoins being one of them. There are a variety of stablecoins. There are fiat backed, decentralized, and algorithmic stablecoins. All having their own pros and cons. There is no one shoe that fits all. We are still in the early stages of experimenting, figuring out which type of stablecoins offers the best trust, decentralization, liquidity and most important stability. Let’s go over the top stablecoins and address the potential risk.
Fiat - backed stablecoins such as Tether (USDT), USD coin (USDC), and BUSD (BInance’s Stablecoin) are currently the top 3 stablecoins. Tether, the number 1 stablecoin has over 77 billion market cap, making it the largest stablecoin issuer in the market. Tether is said to be backed by cash, U.S. treasury bills, corporate bonds, commercial papers and certificates of deposit, funds and precious metals, secure loans, and other forms of investments in its reserves. The recent Terra incident has led some believing that USDT was going to be the next domino to fall. USDT shortly lost its peg due to fear and panic and went as low as 95 cents before returning to its peg. This was understandable seeing the widespread fear that UST has ignited. Investors and traders cashed out 7.7 billion worth of USDT last week due to uncertainty and fear. Therefore, even with Tether being number 1 on the list, one would think it’d be the most stable. Tether is also no stranger to criticism. It has received a lot of attention and bad press due to its vague reports, lawsuits, not being fully audited, and the secrecy on the assets they hold. Tether was fined by NYAG in early 2021 for overstating reserves. Another fine was issued by the CTFC (Commodities Futures Trading Commissions) for over 41 million dollars in late October 2021. Tether might be the largest stablecoin with the highest trading volume, but the risk of it imploding one day is still within the realm of possibility due to its shady history and unknown reserves.
USD coin (USDC) is the second largest stablecoin behind Tether. It is fully audited and backed with cash and U.S treasuries. Currently it has a market cap of 53 billion. Many were exchanging their USDT for USDC amidst the panic when USDT depegged momentarily. USDC has been one of, if not the most stable stablecoin of all. BUSD (Binance’s Stablecoin) is another titan of the stablecoin ecosystem. Binance and Paxos have partnered up to create BUSD. Amassing 18 billion market cap, BUSD has also held up its peg quite well since its inception. The cash backing BUSD is all cash in reserve accounts in the U.S. Bank. Fiat - backed stablecoins are heavily centralized, under constant scrutiny by the government with possible regulations, and the unknown details of their reserves holding up the peg.
Next up we have collateralized stablecoins such as Dai (MakerDao) and MIM (Magic internet Money). MakerDao is a decentralized protocol on the Ethereum blockchain which mints its native stablecoin (Dai) by allowing users to deposit crypto assets as collateral. Dai currently has a 6 billion dollar market cap. The most deposited collateral as of now is Ethereum and USDC. MakerDao is one of the earlier, more established projects within the emergence of Defi 1.0. As of now it is still standing strong, and the only problem I see with it is that it holds too much USDC questioning its decentralization.
Mim (Magic Internet Money) is another decentralized stablecoin created by Daniele Sesta and revered by his cult-like group (Frog Nation). Mim has held up its peg well even with the downfall of Dani’s infamous story surrounding Time Wonderland (his other project) and Sifu. Mim allows you to deposit a diverse number of coins to mint Mim. Mim currently has a 1.2 billion dollar market cap. The problems I see with collateralized stablecoins are smart contract risk, overcollateralization, and the depreciation of collateral assets. Smart contract risk is always a factor when dealing with crypto. There are bugs and exploits happening all the time. Overcollaterization, requiring more collateral to mint is not the most capital efficient of utilizing your assets. Overcollateralization doesn't allow you to maximize the full potential and utility of your assets. Crypto is still an early asset class, and volatile in nature. Having a collateralized stablecoin can pose significant risk for the protocol and its native stablecoin due to massive liquidations if the market is in a down trend.
Algorithmic (seigniorage) stablecoins, the infamous UST/Luna Algo-stablecoin. Algo - stablecoins are under collateralized or no collateral backing them at all. It uses an algorithm to mint and burn coins depending on the fluctuation of the price. If the stablecoin is higher than 1$ it mints, below 1$ it burns. Furthermore, “UST'' is paired with Luna so that the valuation can be more stable with a symbiotic relationship. Users can buy and sell 1$ UST for 1$ of Luna. When 1$ of Luna is sold for 1$ of UST, the Luna is burned and vice versa. This mechanic works fine if UST remains its 1:1 peg, but that is not what happened in the obliteration of Terra. When UST was exploited, and lost its peg, the uncontrollable cascade downards meant there was no hope of UST and Luna returning to what it once was. UST had a market cap of 18 billion at its peak and now it has been decimated to 600 million. There was also a similar event like Luna regarding the Dei/Deus protocol. Dei, the stablecoin, has lost over 25% of its value and Deus, its governance token, has fallen significantly over the past few weeks. Algorithmic stablecoins are still a high risk experiment. The future of these stablecoins are unknown, and from what we saw from Luna, your portfolio can be destroyed extremely fast if you are not vigilant.
Finally we have fractional algorithmic stablecoin, Frax and its utility token FXS. Frax is partially backed collaterally and algorithmically. The protocol adjusts its collateral ratio when Frax’s supplies are either expanding or contracting. If Frax is trading above $1 the protocol decreases its collateral ratio and if it's below $1 the protocol increases its collateral ratio. Frax started by being fully collateralized with crypto’s on-chain stablecoins, and as demand increased it switched to its “fractional phase” where it is partly collateralized and its fractional-algorithmic phase is activated. During this phase, when Frax is minted, FXS is burned and as Frax is redeemed, FXS is minted. As long as there is demand for Frax, redeeming it for the collateral and FXS mints a similar amount of Frax into the circulating supply on the other end. Frax is an interesting project with strong and unique fundamentals. The team and community is constantly building and making innovations. This is still a risky experiment but I am excited to see what Frax can accomplish in the future.
Stablecoins have been an essential part of crypto’s meteoric rise. Stablecoins offer alternatives versus cash and enable protocols to be innovative and create attractive incentives to allow users to earn yield on their stablecoins. But those attractive yields also come with risk, sometimes risk that will rekt your portfolio (i.e UST). I believe the best way to mitigate your risk is to spread out your portfolio into different stablecoins and have some cash. Only deposit into protocols that are battle tested with good track record, and security audits. (Not Financial Advice) There are always smart contract risks, government regulations, and black swan events. Even with the recent events with Luna, the short lived panic on Tether, I believe that stablecoins are here to stay. Many new innovative projects will emerge from the cocoon of this bear market. There will be new ponzis but also revolutionary innovations that will be important building blocks of building a truly decentralized digital ecosystem as crypto was intended for.
Note: None of this financial advice. It is purely for entertainment purposes only.
I came from crypto Reddit! Nice read
I like this , what about Luna?