Recent disruptions, such as the loss of Tether’s peg to the dollar and the collapse of TerraUSD, cast doubt on the stability of these digital assets.
The exponential rise of stablecoins, marketed as a stable form of crypto, has sent ripples through the financial world. Touted for their potential to facilitate faster and cheaper transactions, stablecoins have gained popularity among traders and investors.
However, it is becoming increasingly apparent that stablecoins might not be as stable as they claim to be. This could potentially affect individual investors and the financial market in general.
Stablecoins Unexpectedly Not So Stable
Unlike other cryptocurrencies, stablecoins are pegged to an asset, often the US dollar. By tying their value to a less volatile asset, stablecoins seek to offer the best of both worlds: the speed and privacy of cryptocurrency without the price fluctuations.
Actually, the cracks in this model are beginning to show, causing great investor uncertainty and market disruption.
“We found strong evidence of stablecoin instability, although these deviations from the $1 mark gradually correct at different rates for all stablecoins. [Sometimes,] the deviations do not converge even in the long term due to the non-stationarity of the differentiated series between their price and the $1 mark,” concluded Kun Duan, a researcher at Huazhong University of Science and Technology.
Stablecoins have been largely used to enable speculative trading in other crypto assets. Tether and USD Coin, the two largest stablecoins on the market, claim to be fully asset-backed. Transparency and oversight of issuers’ ability to meet redemption requests, though, have come under scrutiny.
Some Major Stablecoins Lose US Dollar Peg
In some cases, regulators have raised concerns about the liquidity, quality, and valuation of reserve assets held by stablecoin issuers. Tether, once considered a beacon of stability, faced a loss of investor confidence. Subsequently, USDT temporarily lost its peg to the US dollar on June 15.
Similarly, TerraUSD, one of the largest algorithmic stablecoins, crashed when it failed to maintain its peg, which led to significant investor withdrawals and the interruption of its stabilization mechanism. These interruptions are not mere flashes, as they demonstrate an inherent vulnerability in stablecoin design, particularly those that are not fully backed by high-quality liquid assets.
“We have a lot of casinos here in the Wild West, and the poker chip is these stablecoins on the casino gaming tables,” said Gary Gensler, chairman of the United States Securities and Exchange Commission (SEC).
The risk of rapid withdrawals of funds may compromise the issuers’ ability to redeem the full amount due to illiquid assets. Such risk is similar to that faced by other financial investment products. Nevertheless, it is magnified for stablecoins due to the opaque and unregulated nature of the crypto ecosystem.
Tether has faced regulatory fines for claims that its stablecoin is “fully backed by US dollars.” It was found to be investing part of its reserves in risky and illiquid assets with only a small cushion of capital. Other large stablecoin issuers have placed restrictions on redemptions, further eroding investor confidence.
To conclude, investing in stablecoins carries both market, liquidity and operational risks, including cyber and fraud risks. Investors have few resources for lost or stolen crypto assets in the current regulatory environment.
The potential impact extends beyond individual investors. As stablecoins become more integrated into the banking sector, they could pose broader risks to financial stability.
By Marina Meza
