Stablecoins: Are they no longer safe?

This article is part of Crypto Insights, a segment by major crypto exchange Bybit that dives into the latest and most pertinent issues in the crypto space.

In the wake of TerraUSD’s collapse, a Financial Times columnist recently asked, “What could stablecoins ever do that non-blockchain-based payments solutions couldn’t do better?” Here’s what we think.

Photo credit: rokastenys / 123RF

For one, we can access higher yields with stablecoins than the tiny amount offered by banks. We can also send money from wallet to wallet instantly without waiting for the SWIFT system or Western Union to crank into action. And let’s not forget all the unbanked people living in countries with hyperinflated currencies, desperate to hold dollar-equivalent assets.

Stablecoins are synthetic dollars that live on blockchains such as Ethereum and Avalanche. They allow users to quickly trade assets, providing a store of value during times of volatility and opportunities for arbitrage.

We previously published an article suggesting that digital dollars issued by the US government could be a boon to crypto markets due to the high level of trust in its backing. However, in this article, we will be assessing some of the main stablecoin options in circulation.

Tether and USD Coin

Tether (USDT) and USD Coin (USDC) are collateralized stablecoins, which means they’re backed at a 1:1 ratio by assets held by Tether Limited and Circle, respectively. USDT has a market cap of over US$70 billion and USDC of over US$50 billion, making them the two largest stablecoins by quite a margin.

While neither company publishes the granular details of their reserves, independent accounting firms undertake regular reviews and publish attestations that the reserve fund is equal to or exceeds the value of the circulating tokens. This is not as comprehensive as a formal audit, however.

USDT briefly lost its peg during the Terra meltdown as investors panicked and sold the stablecoin faster than arbitrageurs or redemptions from the company could keep up. However, USDT did catch up and has so far redeemed over US$10 billion worth of the tokens back into dollars. USDC, one of USDT’s main competitors, was one of the recipients of this capital flight and actually traded at a US$0.2 premium during the height of the TerraUSD crisis.

The collapse has shown that panic and low liquidity can destabilize even the largest stablecoin, albeit for a brief time. Furthermore, without an independent audit of their reserves, investors have to trust that both companies aren’t hiding anything from their accountants.

MakerDAO and its stablecoin Dai / Image credit: MakerDAO

MakerDAO and Dai

Created in 2014, MakerDAO was one of the first decentralized autonomous organizations in crypto and is now one of the oldest and most respected. In 2017, it launched its stablecoin, Dai.

Dai is backed by overcollateralized loans on crypto assets, which means each of the stablecoins is backed by digital assets to the tune of at least 150%. If the value of the collateral drops due to market volatility, borrowers must deposit more or face liquidation.

Frax