The entire stablecoin market is now worth over $160 billion.
Justin Tallis | AFP via Getty Images
Regulators are increasingly worried about stablecoins following the collapse of controversial crypto venture Terra.
TerraUSDan “algorithmic” stablecoin that is meant to be tied 1-1 with U.S. dollarwiped off most of its value this week after a startling banking run that abruptly wiped billions of dollars off its market value.
Also known as UST, the cryptocurrency works by using a complex cryptographic mechanism combined with a floating token called luna to balance supply and demand and stabilize prices, as well as a pile of billions. dollars bitcoin.
Tether, the world’s largest stablecoin, also slipped below the expected $1 level within hours on Thursday, raising concerns about the potential for contagion from the fallout of the UST de-peg. Unlike the UST, tether is supposed to be backed by enough assets held in a reserve.
US Treasury Secretary Janet Yellen directly addressed the issue of both UST and tether “breaking the coin” this week. During a congressional hearing, Yellen said such assets do not currently pose a systemic risk to financial stability – but suggested they could eventually.
“I wouldn’t describe it on this scale as a real threat to financial stability but they are growing very rapidly,” she told lawmakers on Thursday.
“They represent the same type of risk that we’ve known for centuries in relation to banking.”
Yellen has urged Congress to pass federal regulation of stablecoins by the end of the year.
The UK government is also taking note. A government spokesman told CNBC on Friday that it is ready to take further actions on stablecoins following the collapse of Terra.
“The government has been clear that certain stablecoins are not suitable for payment purposes because they share characteristics with unsupported cryptocurrencies,” the spokesperson said.
I’m planning bring stablecoins within the scope of electronic payments regulationthis could make issuers like Tether and Circle subject to scrutiny by the country’s market watchdog.
Separate proposals within the European Union will also bring in stablecoins under strict regulatory supervision.
They are like casino chips for the crypto world. Traders buy tokens like tether or USDC with real dollars. The tokens can then be used to trade bitcoin and other cryptocurrencies.
The idea is that, whenever someone wants to cash out, they can get the same amount of dollars for how many stablecoins they want to sell. Stablecoin issuers are meant to hold a sufficient amount of money in proportion to the number of tokens in circulation.
Today, the entire stablecoin market is worth more than $160 billion, according to data from CoinGecko. Tether is the largest company in the world, with a market value of around $80 billion.
UST is a unique case in the stablecoin world. Unlike tether, it doesn’t have any actual cash to back its value to the dollar – although it did at one point. partly backed by bitcoin.
Instead, UST relies on a system of algorithms. It went something like this:
- The price of UST can drop below a dollar when there are too many tokens in circulation but not enough demand
- smart contracts – lines of code written into the blockchain – will kick in to remove excess UST from the supply and create new units of tokens called Moonlighthas a floating price
- There is also an active arbitrage system where traders are incentivized to profit from the difference in the price of two tokens.
- The idea is that you can always buy $1 worth of luna for a UST. So if UST is worth 98 cents, you can essentially buy one coin, swap it for luna, and pocket 2 cents of the profit.
Luna, UST’s sister token, is now basically worthless after previously hitting $100 a coin earlier this year.
The entire system is designed to stabilize the UST at $1. But it collapsed under pressure to liquidate billions of dollars — especially on Anchor, a lending platform that promised users interest as high as 20% on their savings. Many experts say this is unsustainable.
The main fear is that a major stablecoin issuer like Tether might go through a “bank run” next.
Yellen and other US officials often compare them to money market funds. In 2008, the Main Reserve Fund – the original money market fund – lost a net asset value of $1 a share. The fund holds some of its assets in the form of commercial paper (short-term corporate debt) from Lehman Brothers. When Lehman went bankrupt, investors fled.
Previously, Tether said its reserves consisted entirely of dollars. But it reversed this position following a 2019 settlement with the New York attorney general. Disclosure from the company shows that they have very little cash but a lot of commercial paper of unknown origin.
Tether now says it is reducing the amount of commercial paper it owns and increasing its holdings of US Treasury bills.
Ratings agency Fitch said in a note on Thursday: “We expect recent developments to lead to increased regulatory requirements for stablecoins.”
According to Fitch, while the risk of stablecoins like tether “may be better controlled” than cryptocurrencies like UST, it ultimately depends on the creditworthiness of the companies that issue them. , according to Fitch.
“Many regulated financial institutions have increased their exposure to cryptocurrencies, defi, and other forms of digital finance in recent months, and several Fitch-rated issuers may be affected. affected if the volatility of the crypto market becomes severe,” the company said.
“There is also the risk of an impact on the real economy, such as through a negative asset impact if crypto asset values plummet. However, we think the risk is for institutions. Issues are rated by Fitch and real economic activity is generally very low.”