Stablecoins are digital assets sometimes called coins, sometimes tokens, that are designed to hold their value. That is, to know only the type of volatility observed in traditional currencies, whose price fluctuations are generally much lower than those of Bitcoin. Tether, for example, sells its coins for $1 and promises to buy them back for $1 if customers want their money back.
In one of two ways. Collateralized stablecoins are pegged to another asset, like the US dollar, and their issuers say they back up the value of their coin by holding that asset or something equally safe. Other stablecoins are pegged to the price of crypto assets such as Ether or, in some DeFi (decentralized finance) applications, collections of coins pledged as collateral. Some use algorithms to manage supply and demand and therefore value. TerraUSD, also known as UST, is this type of stablecoin.
3. How do algorithmic stablecoins work?
They are designed to maintain their parity (and investor confidence) through a combination of mathematical equations and active trading. In the case of UST, investors can trade one unit of the token, regardless of what price it is currently trading at, for $1 worth of a related token, Luna. This means that if the value of the UST slides up or down, an arbitrage opportunity is created – if it drops to $0.98, the theory is that traders will rush to trade it for 1 $ de Luna and will earn $0.02 on the exchange. The creators of the coin relied on this mechanism to keep the UST at or near $1.
Why its value started falling below $1 in early May is unclear. But its subsequent drop to 45 cents illustrated a vulnerability that had derailed a number of previous algorithmic stablecoin projects: UST’s value depends on users’ trust in Luna’s value, and Luna’s value is ultimately based on confidence that UST will remain stable. Backers of UST rolled out a reserve of Bitcoin and another cryptocurrency called Avalanche and pledged that it would buy up to $10 billion worth of Bitcoin forward to back the value of UST. Do Kwon, the currency’s main backer, has updated a plan to save the UST peg by allowing more Luna tokens to be created, so that the market can absorb all the outgoing UST. But this will come at a “high cost”, he tweeted: Luna’s price would in theory drop even further as the increased supply would dilute the value of individual tokens.
5. How many stablecoins are there?
There are dozens of stablecoins in use, with a combined market value that topped $130 billion in October, with more to come. Most of those with a large following are tied to the US dollar. But the biggest one is Tether, which is issued by Tether Holdings Ltd. There are now over 69 billion Tethers in circulation, with at least 48 billion issued this year.
6. Why are coins popular?
Stablecoins can be a bridge between two worlds that were not designed to mix: cryptocurrencies and traditional finance. This makes them useful as a way to lock in gains from crypto trading or as a safe haven if investors think a downturn is ahead. They also facilitate the transfer of funds to crypto exchanges. Many exchanges lack the bank relationships necessary to offer regular currency deposits or withdrawals, but can and do accept stablecoins such as Tether. Finally, stablecoins can streamline, speed up, and make purchases and money transfers cheaper by using a different technology called blockchain instead of traditional payment infrastructure.
7. What are financial regulators saying?
In a highly anticipated report, the Treasury Department, Federal Reserve and other regulators have urged lawmakers to let them police stablecoin issuers the same way they police banks, with robust capital requirements and constant monitoring. But as Plan B, the President’s Financial Markets Task Force has made clear it will activate a rarely used power to review whether coins pose a systemic threat to financial stability – a review that could trigger a series of new rules.
Regulators say the growing size of stablecoins has created a situation where huge amounts of US dollar equivalent coins are traded without touching the US banking system, potentially blinding regulators to illicit funding. “They’re like money funds, they’re like bank deposits, and they’re growing incredibly fast but without proper regulation,” Federal Reserve Chairman Jerome Powell said in congressional testimony. Regulators are also worried about a panic causing something like a bank run. Money market funds needed quick action from the Fed during the 2008 financial crisis and the Covid-19 stock market crash in 2020 to save uninsured investment pools from a potential meltdown.
9. What is on offer?
While the recommendations envision stablecoins as a regulated banking product, the task force report points out that the Securities and Exchange Commission, Commodity Futures Trading Commission and other agencies can monitor transactions in the interim that involve exchanges. , loans and borrowings. Regulators also lay out the reasons to oppose a situation where stablecoins are backed by a big tech company or another giant. The report calls for a wall between tokens and non-financial businesses, mimicking the long-standing divide between banking and commerce. Such an idea could stifle efforts by Meta – the company formerly known as Facebook Inc. – and its partners to launch a stablecoin under the name Diem or to provide customers with crypto wallet services. Facebook recently began trials of a new crypto wallet service using a Paxos stablecoin.
10. What are the issues with Tether?
Yes, there have long been doubts about Tether, the domain giant with $69 billion in assets. A persistent group of critics have argued that, despite the company’s assurances, the companies behind Tether do not have enough assets to maintain the 1-to-1 exchange rate, which would mean the coin was traded d ‘a way that is essentially a fraud. Tether tried to dispel those doubts by posting attestations from an accounting firm that it had the money, but those raised other questions. The US Department of Justice has also opened a criminal investigation into whether Tether executives committed bank fraud.
11. What is Tether backed on?
A Bloomberg Businessweek survey, published on October 7, found that Tether’s reserves include billions of dollars in short-term loans to major Chinese companies, which money market funds avoid. He also reported that Tether had made loans worth billions of dollars to other crypto companies, with Bitcoin as collateral. Tether said the vast majority of its treasury notes have high ratings from rating companies and its secured loans are low-risk because borrowers have to put up Bitcoins that are worth more than they are worth. borrow. The coins are fully supported, he added.
More stories like this are available at bloomberg.com