What awaits Stablecoins after $UST collapse?
On May 9, TerraUSD (UST), the largest algorithmic and third largest stablecoin in terms of capitalization, lost its peg to the dollar, dropping to $0.13 per coin. Following him, the quotes of LUNA, the cryptocurrency of the Terra ecosystem used to ensure a stable exchange rate for UST, also collapsed. Of course, the collapse of such an important player in the industry had a negative impact on the entire crypto market, but stablecoins were the hardest hit: most of them lost their link to the assets that ensured their stable exchange rate. Moreover, American regulators drew attention to the situation and began investigating the incident with UST.
How the UST collapse affected the stablecoin market?
The fall in UST has led to increased volatility in almost the entire crypto market. Many altcoins sank by tens of percent, but projects related to the Terra ecosystem lost the most: on average, their internal coins fell by 80% or more. After the publication of the plan to rescue UST, they won back part of the losses, adding 100-200% from local lows, but then continued to decline.
Even the largest stablecoin on the market, Tether (USDT), has fallen to $0.95 and has not yet regained its peg to the US dollar. Tether also transferred more than 1 billion USDT from the TRON blockchain to the Ethereum network and 20 million USDT to Avalanche (the total stablecoin supply has not changed). The company does not plan to “port” all tokens from TRON – more than half of all USDT is issued on this network. After the incident with UST, the Tether issuer changed the structure of the coin reserve: the volume of commercial paper in it was reduced by half, and the funds received were transferred to US Treasury bonds. The company plans to reduce the share of commercial paper further. At the same time, Tether emphasizes that the company has no problems redeeming USDT.
The Future of Algorithmic Stablecoins
UST is the largest, but only one of many algorithmic stablecoins on the market. Nevertheless, after its collapse, a logical question arises: are there any prospects for these digital assets at all?
Experts have been warning about the risks of algorithmic stablecoins for a long time. So, according to The Block Research study of March 2021, it is the rate of algorithmic coins that is the most volatile compared to other stablecoins.
Algorithmic stablecoins, like other stablecoins, should be more transparent and should also be regulated in a similar way to the banking sector. Only in this case they will have a chance to become a worthy replacement for money. Asset-backed stablecoins like the US dollar have centralized management with equity that can hold the peg in times of market turbulence. Algorithmic stablecoins are backed not by assets, but by an algorithm based on supply and demand in the market, which means that it is especially difficult for such coins to maintain a peg during market turmoil. This is exactly what we observed in the case of UST and LUNA.
Without a doubt, the collapse of the UST has seriously undermined the confidence of traders and investors that the algorithmic model of ensuring a stable exchange rate can be sustainable in the long term. Does this mean that such coins have no prospects? No, it does not mean that the market needs such decentralized tools. But the market also needs a stronger collateral mechanism than the one used in the UST.
Now among the main contenders for the place of UST stands out the algorithmic dollar stablecoin USDD, which was launched on May 5, just a couple of days before the collapse of UST.
Tighter regulation of the stablecoin market.
The collapse of UST could lead to tighter regulation of the stablecoin market around the world. In the US, there is still no separate regulation of stablecoins, although its need is long overdue. In a March executive order to regulate cryptocurrencies, President Joe Biden called on Congress to develop measures to regulate stablecoins. For example, the US presidential administration wants stablecoin issuers to be subject to federal supervision, ideally complying with the requirements of the Federal Deposit Insurance Corporation (FDIC), which US banks now comply with.
At the same time, on May 9, the US Federal Reserve System (FRS) in its financial stability report noted that investments in stablecoins pose risks, since during financial crises the value of assets that back stablecoins may decrease or they may even become illiquid. Moreover, stablecoins can also affect the traditional financial system by putting pressure on their underlying assets.
Confidence has been shaken, but the market stablecoin is alive
The collapse of UST is a precedent in the crypto market. No major stablecoin has depreciated so quickly and so much. But we do not think that the event will seriously shake the stablecoin market.
Stablecoins are an essential part of the crypto industry and the DeFi market. At the same time, the largest stablecoins like USDT or USDC have been successfully operating on the crypto market for a long time, being in high demand. The collapse of one stablecoin does not yet indicate the problems of the entire stablecoin sector. Moreover, problems with algorithmic stablecoins have only strengthened the lead of real-asset-backed stablecoins.
Investor confidence in a particular project, no doubt, may decrease, but the entire stablecoin market is not yet in danger of a major collapse.
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