Amid the chaotic events surrounding last week’s collapse in LUNA and UST…
…the market cap of Tether (USDT) – the largest stablecoin – plunged more than $7 billion. As The FT reports, Tether’s market value has fallen by 9% since May 12 to $76bn as tokens have been removed from circulation to meet redemption requests, CryptoCompare data show.
The decline came after USDT last Thursday traded at about 95 cents, well below the $1 level it seeks to maintain following the failure of a smaller rival. Tether is trading back at $0.9988, having stabilized following the brief depegging…
Decrypt’s Andrew Asmakov reports that amid the depegging, Tether, the company behind the stablecoin, stated that in times of market volatility, it continued to honor all redemptions from verified customers, with about $2 billion processed on May 12 alone.
Tether Continues to Honour All Redemptions from Verified Customers During Market Volatility, On Track To Process 2bn Today https://t.co/p1AugHb9Gn
— Tether (@Tether_to) May 12, 2022
According to Tether CTO Paolo Ardoino, the company has redeemed $7 billion in the past 48 hours, all “without the blink of an eye.”
We have redeemed 7B in 48h, without the blink of an eye. How many institutions can do the same?
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.
— Paolo Ardoino (@paoloardoino) May 17, 2022
As observed by Glassnode, other major stablecoins, such as Circle’s USDC, Binance’s BUSD, and MakerDAO’s DAI, experienced a 1% to 2% premium during Tether’s redemption wave.
Just as USDT’s supply shrank, USDC expanded by $2.639 billion over the same span – something that, per Glassnode, may be “providing insight on market preference during times of stress.”
“Given the dominant growth of USDC over the last [two years], this may be an indicator of changing market preference away from USDT and towards USDC as the preferred stablecoin,” reads the report.
The other stablecoin that saw a dramatic change in supply was DAI, which saw supply fall by 24.4%, as $2.067 Billion was burned. DAI is an over-collateralised stablecoin, backed by other digital assets deposited in the Maker protocol.
Notably, as Glassnode notes, despite the high volatility in collateral assets, elevated demand for DAI, and liquidation events, DAI managed to maintain a strong $1 peg, albeit trading at a very slight premium.
As a reminder, Tether and USDC are a different class of stablecoin to USDT, and both are different from DAI.
In fact, we can classify stablecoins into three broad categories: fiat-backed, crypto-backed, and algorithmic.
Fiat-backed stablecoins are tokens that are backed by a reserve of fiat-denominated assets held “off-chain” (i.e. in traditional securities and custody arrangements); they make up the largest share of USD stablecoin market cap among the top 14 stablecoins.
Crypto-backed stablecoins operate in a similar fashion, but rather than being fully-collateralized by a reserve of fiat-denominated assets, they are backed by an over-collateralized pool of cryptocurrencies.
In contrast, algorithmic stablecoins are typically pegged not through the use of reserves, but through an expansion and contraction of the supply of the stablecoin (note that the terminology on these topics varies across the industry).
The exact mechanism through which algorithmic stablecoin pegs are maintained can be quite different, and multiple different models have emerged over the past few years, with most eventually de-pegging or adopting a fiat- or crypto-backed reserve model…
As Goldman’s Isabella Rosenberg and Zach Pandl notes in a recent note, like fixed exchange rates in traditional finance, algorithmic stablecoins are vulnerable to speculative attacks. They also face competitive threats from other forms of public and private money, as did similar assets in earlier experiments with private money in US history
However, this is not a ‘crypto’-specific problem as algorithmic stablecoins, like other stablecoins, resemble pegged fiat exchange rates.
As Goldman notes in its latest note on stablecoins, although fixed exchange rate regimes can be stable over long periods of time (sometimes supported by capital controls), most countries will not hold reserves sufficient to cover all possible tail-risk events, and there will always be some probability that the peg could break. As a result, these systems are vulnerable to runs, crashes, and speculative attacks.
In our dataset covering 109 major currency crashes, many of which are peg breaks, nominal USD crosses depreciate by 45% in the median case over 48 months…
As Goldman concludes, stablecoins provide a useful service within the digital asset ecosystem: users need a less volatile base asset in these markets – ideally without converting back to fiat currency and the traditional banking system, given the frictions and transaction costs involved – and stablecoins have filled this need. However, algorithmic stablecoins in particular are vulnerable to self-fulfilling crises, as is now obvious after the decline of UST and LUNA.
Regulation seems likely, in our view, and appropriate regulation could improve stability and lower risk in the stablecoin market (or possibly displace stablecoins through an alternative government-backed medium). Within the digital asset market, positive network effects from greater non-speculative use cases for these protocols could contribute to a more stable demand base over time.