The past week has not been an easy one. After the collapse of the third-largest stablecoin (UST) and what used to be the second-largest blockchain after Ethereum (Terra), the depeg contagion seems to be spreading wider.
While UST has completely depegged from the U.S. dollar, trading at sub $0.1 at the time of writing, other stablecoins also experienced a short period where they also lost their dollar peg due to the market-wide panic.
Tether’s USDT stablecoin saw a brief devaluation from $1 to $0.95 at the lowest point in May. 12.
FRAX and FEI had a similar drop to $0.97 in May 12; while Abracadabra Money’s MIM and Liquity’s LUSD dropped to $0.98.
Although it is common for stablecoins to fluctuate in a very narrow range around the $1 peg, these recent trading levels are seen only during extremely stressed market conditions. The question that now sits in the mind of investors is will the fear spread even wider and will another stablecoin de-peg?
Let’s take a look at the mechanism of some of the major stablecoins and how they are currently traded in the Curve Finance liquidity pool.
The main purpose of stablecoins is to preserve a stable value and provide investors an avenue to park their money when volatility from other crypto assets are much higher.
There are two distinct mechanisms in stablecoins — asset-backed and algorithm-based. Asset-backed stablecoins are the most common version and issuers purport to back stablecoins with fiat currency or other cryptocurrencies. Algorithm-based stablecoins, on the other hand, seek to use algorithms to increase or decrease the supply of stablecoins based on market demand.
Asset-backed stablecoins were in favor during downturn, except for USDT
USD Coin (USDC), Dai (DAI) and USDT are the most traded asset-backed stablecoins. Although they are all over-collateralized by fiat reserves and cryptocurrencies, USDC and USDT are centralized while DAI is decentralized.
USDC’s collateral reserves are held by U.S.-regulated financial institutions, whereas USDT’s reserves are held by Tether Limited, which is controlled by BitFinex. DAI, on the contrary, does not use a centralied entity but uses the primary market borrowing rate to maintain its dollar peg, which is called the Target Rate Feedback Mechanism (TRFM).
DAI is minted when users borrow against their locked collateral and destroyed when loans are repaid. If DAI’s price is below $1, then TRFM increases the borrowing rate to decrease DAI’s supply as less people will want to borrow, aiming to increase the price of DAI back to $1 (vice versa when DAI is above $1).
Although DAI’s pegging mechanism seems algorithmic, the over-collateralization of at least 150% makes it a robust asset-backed stablecoin during volatile market conditions. This can be seen by comparing the price movements of USDC, USDT and DAI in the past week where DAI, along with USDC, clearly showed a spike on May 12 when investors lost confidence in USDT and rushed to swap out.
Tether’s USDT has long been controversial despite its large market share in the stablecoin space. It was previously fined by the U.S. government for misstating the type of cash reserves they have. Tether claims to have cash or cash-equivalent assets to back USDT. However, a large portion of the reserves turn out to be commercial paper — a form of short-term unsecured debt, which is riskier and is not “cash equivalent” as dictated by the U.S. government.
The recent Terra debacle and the lack of transparency of their reserves triggered fresh concerns about USDT. The price reacted violently with a brief devaluation from $1 to $0.95. Although USDT’s price has recovered and repegged closely back to $1, the concerns are still there.
This is shown clearly in the largest liquidity pool on Curve Finance. The…
Read More: cointelegraph.com