The failure of TerraUSD (UST) has affected the entire crypto ecosystem raising concerns about stability of stablecoins.

Bitcoin and Crypto DeFi watch Thursday, May 12, 2022 - 19:25

Stablecoins are a class of crypto assets that do not change in value over time. They represent a market cap of $170 billion as of today which is approximately 12% of the global crypto market. They contribute to nearly 96% of all crypto transactional volume on a daily basis. In this article we explore the use cases of this subset of crypto assets and why they are becoming prominent and controversial day by day.

Stablecoins: an introduction

Stablecoins are crypto assets that are essentially pegged to real world fiat currencies, especially the US dollar. Its issuers maintain their value constant through either of the two mechanisms: 1) collateralization (asset backing in real world) and/or 2) algorithmic (through the use of smart contracts). Stablecoins play an important role in bridging the gap between traditional finance and decentralized finance as they represent the closest counterpart to fiat currencies like USD, JPY, INR etc. They give investors an ideal measurement system through which they can transact and evaluate their portfolio.

Their growth over the years have been phenomenal - from a value of around $1 billion in 2018 to more than $170 billion today, they also represent the growth in crypto adoption over the years.

Understanding their use cases

The primary use case of stablecoins is during transactions. Crypto investors have faced difficulties in repeatedly converting their country’s currency into the blockchain ecosystem. Transactional delays, conversion fees etc have plagued them over the years. Hence, slowly, they have started preferring a bulk conversion to stablecoins which are trackable on the blockchain.

Also, some traders convert their profits into stablecoins and wait for a dip in the market to buy more crypto - essentially keeping their holdings and profits within the blockchain ecosystem. Thus, the non-volatile nature of stablecoins in a volatile crypto market have made them a key instrument for investors and traders alike.

Another feature that favors usage of stablecoins is the ability to transfer them between crypto exchanges - irrespective of their centralized or decentralized  nature. Decentralized exchanges (DEXs) often do not provide an on-ramp service (fiat-crypto exchange service) for trading. DEXs therefore only accept stablecoins or other cryptocurrencies as primary basis to buy/transfer between assets. Stablecoins also represent an easy way to transfer value in cross-border transactions with minimal blockchain fees.

The final use case they represent is the ability to stake them and earn high interest. Because they are pegged to a currency, staking them for a period of time becomes equivalent to a fixed deposit in a bank. Staking stablecoins currently earn upto 12% annual interest rate, higher than most bank deposits globally.

Controversies and regulation

Although stablecoins are on the blockchain, there are concerns about what is actually backing them. If they are not fully backed by assets such as dollars, gold etc, they can lead to systemic risk given no Government can control their supply which is theoretically unlimited. For example, Tether (USDT), a US dollar pegged coin with more than $75 billion market cap, is under investigation in the US on how it is backed by assets in the traditional financial system.

More recently, TerraUSD (UST), an algorithmic stablecoin crashed more than 50% losing its peg to the dollar. The failure of UST is having reverberating effects across the entire crypto industry and Terra (LUNA) which is currently backing the UST has lost 99% of its value in just three days.

Post the UST fiasco, the most widely used stablecoin USDT has come under extreme pressure and has lost its peg to the dollar dropping below $0.98. The panic around the biggest stablecoin on the crypto market is speculative and psychological as Tether's reserves are at a significantly higher level compared to UST, which was backed with two extremely volatile assets like Bitcoin and Luna.

One way to circumvent these issues is through issuance of Central Bank Digital Currencies (CBDCs) that are controlled by individual Governments. In fact, RBI in India is planning to introduce a digital rupee that can be considered as a stablecoin though there is daily variance with respect to US dollar - INR rates.

Overall, stablecoins have addressed a large need gap in the crypto transactional market and are set to grow further as adoption and demand increases. However, their issuers may be subject to regulatory oversight in the near future which will pave the way for a more robust issuance and usage of this crypto sub class. Investors are advised to view stablecoins as a bridge to the crypto world and not hold their wealth in them for long term.

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Disclaimer: This article was authored by Giottus Crypto Exchange as a part of a paid partnership with The News Minute. Crypto-asset or cryptocurrency investments are subject to market risks such as volatility and have no guaranteed returns. Please do your own research before investing and seek independent legal/financial advice if you are unsure about the investments.

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