They are digital assets designed to hold a steady value, in contrast to the price volatility seen in Bitcoin and other so-called tokens. They’re usually pegged to another currency, most commonly the US dollar. That makes stablecoins useful for crypto investors who need to park their profits somewhere safe but don’t want to convert them back into real money. One of the most popular stablecoins, Tether, can be exchanged for thousands of other cryptocurrencies. There are dozens of stablecoins in use, with a combined market value that topped $180 billion at the beginning of May before the TerraUSD collapse and a broader slump in crypto assets.
2. How do they maintain their value?
Many stablecoin issuers say they hold cash or other assets to match the value of the stablecoin in circulation. So when a user pays Tether $1 for a token, that money is supposed to be held in safe assets. Others maintain reserves of cryptocurrencies rather than traditional money but “overcollateralize,” meaning the reserves are larger than the face value of the stablecoins to compensate for their volatility. Another category known as algorithmic stablecoins use automated operations meant to maintain their value. Some achieve this by adjusting their supply — generating more coins when they trade above their pegged value so that the price comes down, and removing some from circulation when they fall below the peg so the price goes up.
3. What went wrong with TerraUSD?
TerraUSD was an algorithmic stablecoin that used a parallel floating-rate currency, Luna, to back up its fixed dollar exchange rate. What made it popular was the fact that users could deposit their coins and earn 20% interest in an experimental lending project called Anchor. TerraUSD’s peg to the dollar began to break with a series of large withdrawals from Anchor and the Curve crypto exchange, and both TerraUSD and Luna plunged to near zero within days. To critics, the only thing sustaining TerraUSD had been the money pouring in from investors convinced it would keep growing. When that optimism evaporated, there was nothing left to sustain it.
TerraUSD’s collapse sparked a broader selloff that wiped $200 billion off of the market capitalization of all crypto assets in a day, briefly knocked Tether off its peg and raised new questions over the safety of stablecoins. Many are managed by private organizations that are under no legal obligation to protect their reserves or maintain the liquidity of the tokens. Traditional currencies are backed by governments and have survived multiple crises. The group behind Tether, the most important stablecoin, was forced to pay $41 million to US regulators in 2021, in part to settle allegations that it lied in claiming its tokens were fully backed by assets in fiat currencies. It admitted no wrongdoing.
5. What do regulators fear?
They worry about the risk of more stablecoin crashes that could trigger fire sales of other assets as their backers try to maintain a peg. Even more worrisome is the converse scenario — that stablecoins prove their worth, soar in popularity and allow vast sums to change hands without touching the formal banking system, undermining the monetary monopoly of central banks and enabling criminals to engage in massive money laundering.
6. What do they plan to do?
The US Federal Reserve wants the power to police issuers the way it does banks, with robust capital requirements and constant supervision to ensure their stability. Some central banks are even devising their own digital tokens that would make transactions faster and cheaper than with regular cash, but safer than private cryptocurrencies. In the days following the TerraUSD collapse, European Central Bank President Christine Lagarde said that cryptocurrencies are “based on nothing” and that a digital euro would be “vastly different.”
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