Crypto Startups Venture

Mergers & Money: The Instability Of Stablecoins

Editor’s note: Mergers & Money is a monthly column by Senior Reporter Chris Metinko that covers dealmaking and the flow of venture capital.

As TerraUSD kicks around 10 cents, it’s fair to wonder how a so-called “stablecoin” could lose 90 percent of its value in just days?

It is also legitimate to wonder what this means in the broader context of the stablecoin market and larger players like USD Coin and Tether? However, it may be difficult to draw real conclusions about the entirety of the industry based on the dramatic downturn of TerraUSD—also known as UST.

What is a stablecoin

Before talking about why UST’s fall may not foreshadow a reckoning for all stablecoins, it is important to understand what is a stablecoin.

Search less. Close more.

Grow your revenue with all-in-one prospecting solutions powered by the leader in private-company data.

Stablecoins are an offshoot of cryptocurrency. However, instead of rising and falling like Bitcoin or ether, which depend on trading in the market, stablecoins are designed to maintain a set value — such as one coin equalling $1.

How they are tied to that price, however, varies greatly. There are three distinct types of stablecoins in the market currently. Some are backed by fiat currencies, cash equivalents and other assets. USD Coin—issued by Centre, a joint venture between Coinbase and Circle—is an example.

Tether also claimed its tokens were backed similarly. However, last year it settled charges from the New York Attorney General’s office that it did hold proper reserves of U.S. dollars to back all its coins (we’ll get back to this later).

A second classification of stablecoins are backed by other crypto assets—which themselves have been unsteady as of late.

The last classification is algorithmic stablecoins—which is where UST falls. Algorithmic stablecoins use financial engineering to maintain their 1-to-1 peg between the backup assets. In UST’s case, it is pegged to a cryptocurrency called Luna.

In theory, traders will swap out a UST coin for $1 worth of Luna when prices of the stablecoin drops below $1. When a trader does that, the coin is “burned” removing it from circulation and lessening the supply of UST on the market—which should increase demand. It was thought that engineering would be able to balance supply and demand at a $1 value.

Where to now?

That theory has not held for the last several days, as UST is worth little more than a dime.

The unease in the market seems to have worked its way to other stablecoins. In the past week, Tether has watched investors pull back, as ​​its circulating supply has dropped from more than $83 billion a week ago to just less than $75 billion on Wednesday, according to data from CoinGecko.

Even Tether’s CTO, Paolo Ardoino, responded to concerns on Twitter this week about how the tether stablecoin is backed. In the last breakdown of its reserves on its website issued at the end of last year, Tether said about 84 percent of reserves were made up of “cash and cash equivalents and other short-term deposits & commercial paper,” but of that 52 percent consisted of treasury bills.

“We can keep going if the market wants, we have all the liquidity to handle big redemptions and pay all 1-to-1. Yes, Tether is fully backed,” he tweeted.

However, not all news has been bad in the stablecoin ecosystem. USD Coin has watched its market cap get a slight bump over the last week, up from about $48.5 billion to now more than $52 billion.

Not going anywhere

The fact that even as doubt has swirled around the market, the second-largest stablecoin saw a market cap increase showing the popularity of a currency that toes the line between crypto and traditional.

According to a report in November of last year from the President’s Working Group on Financial Markets, stablecoin supply grew from $21.5 billion in October 2020 to $127.9 billion as of October 2021—representing an increase of approximately 495 percent.

The popularity is not a complete surprise. As stated above, they are a unique combination of crypto and more traditional money, since their value is locked. However, they can be used on crypto exchanges—which don’t often use regular currency.

Stablecoins also can speed up and make things such as money transfers cheaper by staying off traditional payments infrastructure.

That is not to say there is no concern. It is odd that so many stablecoins are pegged to a $1 equivalent, but never touch the U.S. banking infrastructure.

Some, like Federal Reserve Chairman Jerome Powell, have pushed for tighter regulation of stablecoin, comparing them to money market funds. Money market funds needed to be saved by the Fed during the 2008 financial crisis and during the early COVID pandemic days. The move was meant to keep people, who were afraid their uninsured commercial paper would lose value, from cashing in their funds.

“We have a pretty strong regulatory framework around bank deposits, for example, or money market funds,” Powell told Congress in July. “That doesn’t exist currently for stablecoins, and if they’re going to be a significant part of the payments universe—which we don’t think crypto assets will be but stablecoins might be—then we need an appropriate regulatory framework.”

After this week, regulators are unlikely to unwind those calls for more oversight.

Illustration: Dom Guzman

Stay up to date with recent funding rounds, acquisitions, and more with the Crunchbase Daily.

Copy link