Stablecoins are one of the most important components of the crypto ecosystem.
The stablecoin market has grown significantly over the past two years, and such tokens rely on different methods to maintain a stable value relative to one or more currencies or other assets, including cryptoassets.The stablecoin market cap was over $160 billion at its peak and is currently at $142.82 billion.
In 2022, volatile market conditions caused investors to withdraw from other tokens, the collapse of Terra (LUNA) and the ensuing liquidity crisis caused a large amount of value to be transferred to stablecoins, and the importance of stablecoins was further weakened. strengthen. More recently, the news and legal action surrounding Tornado Cash has put stablecoins at the center of public opinion.
- In two years, the total stablecoin supply increased by 816% to $142.82 billion;
- Tether (USDT) is the second most traded cryptocurrency (approximately 60% of BTC’s daily trading volume) and entered the top 10 cryptoassets by market cap earlier this year;
- Tether (USDT) dominance has dropped 44% since 2020;
- AAVE is launching GHO, a decentralized, algorithmic, yield-generating stablecoin that enhances its lending protocol;
- USDC issuer Circle and USDT issuer Tether announce support for Ethereum merger; MarkerDAO (DAI) and Grayscale express concern.
Stablecoins: what are they and how big is their market cap?
Stablecoins are digital currencies stored on distributed ledger technology (DLT, usually a blockchain), pegged to a reference value. The vast majority of existing stablecoins are pegged to the U.S. dollar, but stablecoins may also be pegged to other fiat currencies, currency baskets, cryptocurrencies, or commodities such as gold.
Stablecoins differ from ordinary digital currencies (such as electronic bank deposit accounts) in two key ways.First, stablecoins are cryptographically protected. This enables users to settle transactions very quickly without suffering double-spending or third-party attacks. This also enables transactions 24 hours a day, 7 days a week, 365 days a year on a public blockchain.
Second, stablecoins are often based on programmable DLT standards that provide service composability. In this sense, “composability” refers to the ability of stablecoins to function as independent building blocks, interacting with smart contracts (self-executing programmable contracts) to generate payments and other financial services. These two fundamental characteristics allow for innovation in both financial and non-financial sectors and form the basis for existing stablecoin use cases.
Stablecoin usage soars
The usage of stablecoins recorded on public blockchains such as Ethereum, BNB Chain and Polygon has increased significantly since 2020. On August 17, 2022, the largest FIAT-pegged public stablecoin had a circulating supply of approximately $132 billion. In two years, the circulation increased by 880%. However, just four months after the Terra LUNA crash, the stablecoin’s circulating supply plummeted by 10% ($14.94 billion).
Looking at the total stablecoin supply, we can observe that 92.42% of the value is represented by fiat-backed stablecoins, currently at $142.82 billion, an increase of 816% since August 2020. In May, following the collapse of Terra Luna on the 9th, the total supply decreased by 14.6% ($26.35 billion) in just five days. It continued to drop 7% ($11.34 billion) in June when cryptocurrency firm Celsius announced a withdrawal freeze.
In terms of stablecoin dominance, Tether USDT leads with 46.65% market share, followed by USDC with 31.41% market share, BUSD with 12.57%, DAI with 5.09% and others with 4.28%.
It is important to note that in August 2020, Tether (USDT) dominance was 83.76%, down 44% in two years.On the other hand, since August 2020, the dominance of BUSD and USDC has increased by 845% and 298%, respectively.
In the graph above, we can observe how the dominance of the three major stablecoins increased when Terra collapsed. However, Tether lost 5% ($12 billion) when Celsius announced a withdrawal freeze. This happened mainly because Tether, known as an early investor in lending crypto companies, contributed $10 million in equity investments to the lending platform in 2020. Additionally, Celsius reportedly borrowed $1 billion (BTC) from Tether using Bitcoin as collateral in the following year, 2021.
It is important to note that Tether issued a statement explaining that its portfolio of Celsius has nothing to do with the health and support of USDT.
What makes stablecoins pegged? Lessons from UST and aUSD
The most important indicator of the performance of any stablecoin is the degree to which the asset pegs it to a reference value. As shown in the table above, stablecoins can be categorized from different perspectives, and each type has its own disadvantages.
At present, the main reasons for the instability of reserve-backed stablecoins are the risk of investors withdrawing funds from the issuer and the price fluctuations in the secondary market. The stablecoin reserves are sufficiently safe and trustworthy to be the first priority.
If stablecoin holders become suspicious of stablecoin support, it could lead to peg volatility. A run on stablecoins increases the risk of spillovers to other asset classes as stablecoin reserves are sold to meet redemption demand.
Through the use of interoperable smart contracts, stablecoin volatility can also harm markets and services that rely on stablecoins.
A second type of peg instability can occur with stablecoins backed by public reserves. In this case, there is a contradiction between supply and demand in the secondary market. Since these stablecoins are traded on centralized and decentralized exchanges, they may be subject to sudden changes in demand.
This could cause their peg to be temporarily interrupted until the stablecoin issuer changes the supply.Especially when markets are volatile, investors rush to convert their speculative assets into stablecoins that act as stores of value in public blockchain-based markets. The price of stablecoins backed by major public reserves typically rises in short periods of time as issuers change supply.
A second stablecoin backed by an algorithmic model appears to be a riskier approach. An example is Terra’s old UST, where the community regulates the price of its stablecoin.
For example, if the price of UST falls to $0.99, LUNA holders can exchange $1 worth of UST for $1 worth of LUNA and gain an arbitrage spread. Therefore, LUNA relies on its clients to arbitrage the spread and maintain price stability. For this system to be successful, it needs a large amount of UST that can absorb whatever amount of UST the market throws at them.
Since UST was not collateralized by its real value when $84 million of UST was dumped onto the market, governance lacked the purchasing power to quickly arbitrage the spread. At that moment, arbitrage starts to crash the whole system, also known as the death spiral.
During this period, the price of one UST has been $0.8. This means that anyone who burns UST in order to produce LUNA tokens will receive $0.20. People continued to use this arbitrage method until LUNA and UST lost almost all their value.
Another example of algorithmic stablecoin volatility is Acala’s native stablecoin, aUSD. However, the aUSD case was caused by a “misconfiguration” in one of the liquidity pools being exploited. Once an attacker exploits the vulnerability, the mass minting of the stablecoin causes its value to collapse.
The network quickly recovered, destroying 1.29 billion aUSD tokens owned by 16 wallet addresses in connection with Acala’s newly announced iBTC/aUSD liquidity pool smart contract hack. According to CoinGecko, the Acala community voted on the burn plan on August 16, which helped aUSD quickly regain its peg to the U.S. dollar and is currently trading at $0.89.
While cryptocurrency market volatility has had a major impact on the status quo of stablecoins, the recent events surrounding Tornado Cash could have a final impact on the future of stablecoins.
Tornado Cash uncovers MakerDAO’s Achilles heel
The U.S. Treasury Department imposed sanctions on Tornado Cash on August 7, 2022, for allegedly helping North Korean hackers, presumed to be the Lazarus Group, launder billions of dollars worth of stolen cryptocurrency. The U.S. Treasury Department’s Office of Foreign Assets Control (OFAC), the regulator responsible for imposing sanctions, has verified the news, preventing U.S. crypto users and companies from dealing with the system.
The OFAC list includes addresses directly related to Tornado Cash, such as its multiple mixing pools. It also cited the Tornado Cash account used by crypto grant program Gitcoin to accept donations, the largest of which came from the hack that caused the $37.5 million Iron Bank breach in February.
Adding an address to the OFAC list prevents the owner from sending or receiving USDC. In the past, most centralized stablecoin issuers, including Circle and Tether, banned malicious individuals.
This time, Circle quickly blacklisted 45 Ethereum addresses as the U.S. Treasury Department’s new penalties for Tornado Cash became known to the public. This wallet veto method is also reportedly used by leading DeFi protocols such as UniSwap, Aave, Balancer, and dYdX, which have blocked blacklisted users.
Tornado Cash’s actions will undoubtedly influence the next wave of regulation. However, this report will focus on the potential impact on MakerDAO and its stablecoin DAI, one of the most decentralized stablecoin offerings in the industry. DAI is the fourth largest stablecoin with a circulation of $7 billion, and its stability mechanism relies on USDC.
Given this, MakerDAO may face an existential crisis. The system, which bills itself as a “fair” and “decentralized” stablecoin that anyone can use, has become reliant on USDC to maintain its dollar-pegged price.
Half of all DAI was originally created from USDC deposits, but today MakerDAO backs its stablecoin with roughly a third of USDC. DAI has benefited from USDC in the past, proving very stable during the year of market volatility.
However, the protocol’s sensitivity to USDC goes beyond centralized vaults, and the stability of the stablecoin is maintained by the Price Stability Module (PSM).
As the name suggests, PSM helps pegg the price of DAI to the U.S. dollar, especially if demand exceeds supply. DAI is only created when over-collateralized deposits are made to the system; if many people want DAI tokens but don’t have enough collateral, a supply crunch could cause the price of DAI to rise by more than the planned $1.
MakerDAO’s answer is PSM, which allows USDC holders to exchange their tokens for “expensive” DAI at USD exchange rates. When the price of DAI exceeds $1, it provides an immediate and potentially lucrative arbitrage opportunity, which will push the price of DAI to parity with USDC. Anyone can transfer USDC to MakerDAO’s PSM, after which the tokens are officially held in MakerDAO custody.
MakerDAO community members have begun developing “emergency strategies” in case the suspension affects their “core” wallets.
Will Ethereum’s “merger” affect the stability of stablecoins?
Stablecoins are central to how DeFi works, as they are often used in DeFi markets to facilitate transactions or as collateral for lending. For example, stablecoins are often used in so-called “automated market makers” (AMMs).
AMM is designed to create liquidity for others looking to make transactions. As another example, stablecoins are often “locked” in DeFi to earn income from the interest paid by others to borrow the stablecoin in leveraged trades or other transactions.
Although unverified, industry metrics that measure the scale of DeFi participation include the percentage of stablecoins “locked” in Ethereum smart contracts. Ethereum is currently the primary blockchain on which DeFi protocols and applications run. That’s why the “merger” is one of the most anticipated events in blockchain history, raising many questions about the stability of stablecoins once the transition is complete.
The merger will transform the Ethereum blockchain (native token ETH) from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) consensus mechanism that uses more than 99.9% less energy. As a result, transactions will take place on the new proof-of-stake network, and new ETH tokens will be minted by nodes on the network and a fair amount of ETH will be pooled to secure the network and validate transactions.
On Aug. 9, Circle, the issuer of the USDC stablecoin, pledged its full support for the “merger” in a blog post.Currently, USDC is both the largest dollar-backed stablecoin issued on Ethereum and the largest ERC-20 asset overall, with a market cap of over $45 billion in the ecosystem at launch. Its reserves are audited and held at U.S. financial institutions such as BlackRock.
After announcing support for Circle, USDT issuer Tether has confirmed support for the upcoming Ethereum merger. Accepting Merge is fundamental to ensuring that their tokens are used in DeFi platforms without disruption to the community, they said.
With the sheer size of these stablecoins and their significant presence in the crypto market, their support for the Ethereum merger makes a lot of sense. Support could see a smooth transition to Ethereum 2.0 across the crypto industry.
Ethereum blockchain co-founder Vitalik Buterin had earlier warned that the power held by stablecoins could cause problems in future blockchain hard forks. Buterin said centralized institutions like Tether and Circle could choose to fork the blockchain to suit their own needs, rather than focusing on what the ethereum community suggested.
But not everyone is enthusiastic about this “merger”. MakerDAO (MKR), creator of the stablecoin DAI, claimed in a Twitter post that the merger did more harm than good. They explained that the merger could lead to perpetual contract backwardation and negative funding. Additionally, MakerDAO mentioned that the launch could trigger selling pressure on existing chains on PoW.
Another prominent risk is the possibility of assets becoming worthless on collateralized Ethereum (sETH).Maker sees this as a big problem because it operates through a system lending protocol. Additionally, it noted that lending protocols have the potential to receive higher ETH deposit rates due to increased liquidity due to the merged fork.
There is also the possibility of network downtime, as not all Ethereum-based protocols will move to PoS via the Ethereum chain. Maker noted that this could affect users and transactions. Likewise, Replay Attacks on DAI-fork or MKR-fork are not excluded from the options.
Additionally, Grayscale expressed concern about the potential impact of Merge, especially on tokens that run natively on Ethereum. The crypto investment firm believes the merger could lead to a fork that could have unintended and adverse outcomes.
Grayscale is concerned that the merger could create a situation where stablecoins and tokens locked in smart contracts may not be redeemable.
The crypto investment firm also noted that token and stablecoin holders could panic and start liquidating their holdings. Such an outcome would create significant selling pressure.
While Grayscale and MakerDAO’s concerns are real, Ethereum developers may have taken them into account.A “merge” may transfer PoW Ethereum data and serve as a handoff. Parachains inevitably lead to duplication.However, strategies and measures to address these issues still exist.
DeFi Protocol Announces New Stablecoins Seeking Users and Liquidity, Does It Help?
The recent popularity of algorithmic stablecoins and the collapse of Project Terra have drawn attention to stablecoins by highlighting the pivotal role of USD-pegged assets in the cryptocurrency ecosystem.
Multiple protocols have proposed new stablecoin efforts to fill the void left by the U.S. dollar (USD) and gain liquidity. The DeFi space is full of gimmicks aimed at enhancing user engagement, and it is likely that stablecoin offerings are just the latest trend to improve TVL on DeFi platforms.
Let’s take a look at some of the recently announced stablecoins that may enter the market:
On July 27th, AAVE Corporation proposed to their community to deploy the new stablecoin GHO on the Aave protocol and enable all users to mint additional GHO tokens by providing sufficient collateral. This stablecoin will be an algorithmic stablecoin that pays interest on the underlying asset, and it will be backed by many cryptocurrencies rather than the U.S. dollar.
Aave has previously warned potential GHO users about issuance limits, peg stability modules, DAO-determined interest rates, and potential facilitators.
The DeFi Aave protocol is the third largest TVL protocol in the world, worth about $6.5 billion, followed by Uniswap and Curve. Its main job is to borrow and lend cryptocurrencies in order to provide liquidity to the cryptocurrency market.
Additionally, the SHIBA Inu ecosystem showcased its own stablecoins, new tokens and collectible card games for its future Metaverse.
The creator of the project said in his blog post that the collapse of TerraUSD (UST) triggered a crisis in the stablecoin market, prompting the Shiba Inu community to create its stablecoin.
Kusama claims that Shiba Inu’s upcoming stablecoin, SHI, can “avoid the flaws found in other assets in the category” because it was developed independently by “a group of developers in our decentralized network.”
No other details about the coin have been disclosed, and a launch date cannot be determined. However, Kusama said that if all goes according to plan, the stablecoin will be released later this year.
On Aug. 8, Kujira, the crypto project built on the Terra Classic blockchain and migrated to the layer-1 protocol Cosmos after the implosion of Terra, announced the imminent development of USK, an overcollateralized Cosmos stablecoin soft-pegged to the U.S. dollar. , originally backed by ATOM in response to the May crash of Terra and its affiliated stablecoin TerraUSD.
The project also wants to avoid relying on larger centralized stablecoins like USDC and Tether (USDT), saying “a decentralized currency requires a decentralized stablecoin” to maintain project sovereignty and prevent the possibility of censorship.
In addition to the new USK token, Kujira currently offers three separate DeFi products for retail investors: ORCA for capital clearing, the FIN decentralized exchange (DEX) and the BLUE governance protocol, with native cryptocurrency wallets in development middle.
Potential regulations that could affect the future of stablecoins
Regulation has long lagged behind the explosive growth and continued technological advancement of the cryptocurrency industry. The move to crypto assets has been delayed due to the uncertain legal environment, but stablecoins continue to grow exponentially.
Some of the largest economies in the world have now begun to develop legislation to identify, understand and structure cryptoassets, provide clarity and security, and keep pace with the pace of change. The UK, EU, US, and Singapore have established stablecoins before, showing that these countries believe in them and expect their widespread adoption.
Here is an overview of current stablecoin regulation:
Since 2018, the European Union has been developing Market Regulations for Crypto Assets (MiCA) to assist in the regulation of crypto assets and related service providers outside the EU. On June 30, 2022, EU lawmakers approved the historic law that will govern cryptocurrency assets and service providers across the continent’s 27 member states.
By requiring stablecoin issuers to accumulate sufficient liquidity reserves on a 1:1 ratio and partly in the form of deposits, MiCA will protect customers. The issuer will always file a claim against each so-called “stablecoin” holder for free. Regulations governing reserve activity will ensure sufficient minimum liquidity. The issuer must have sufficient reserves to cover all claims and provide holders with the opportunity for quick redemption. The daily transaction limit is EUR 200 million for stablecoins.
By 2024, MiCA hopes to provide a uniform licensing system across the EU. Once passed, the Act will immediately apply to all EU member states and companies wishing to do business here. The approval of MiCA by the European Parliament opens the door for innovation-friendly crypto regulation that could become a global standard. However, it may not come into effect until the end of 2023.
Stablecoins like USDC are analyzed under the category of “electronic currency tokens” of cryptoassets, which is described as a digital asset whose primary function is to serve as a medium of exchange and claims to be held by reference to the value of fiat currency stable value. Token- and fiat-backed stablecoin offerings are likely to fall under the category of “crypto-asset service providers.”
More recently, changes to MiCA have been proposed to limit the use of cryptocurrencies using proof-of-work algorithms. A parliamentary committee rejected the idea in March 2022 because proposed regulations could make cryptocurrencies illegal across the European Union. However, the European Commission will include crypto asset mining in the EU classification of sustainable activities by 2025 in order to reduce the carbon impact of cryptocurrencies. In addition, consumer safety and protection initiatives were approved.
The definition of “Money Transmission Services” currently includes transactions using stablecoins. This suggests that if a company accepts and transmits stablecoin activity, the company is considered a money transmitter under the Bank Secrecy Act. Because the U.S. regulatory environment is divided into several regions, it is important to note that the rules vary from state to state. In this case, stablecoins may be subject to money transfer laws, and depending on the level of activity, a money transfer license (MTL) would be necessary. Additionally, the business must be registered as a Money Services Business (MSB).
Stablecoin issuers like Circle, which apply to become fully-reserved national commercial banks in 2021, will be affected by current negotiations on stablecoin regulation. Once a banking license is obtained, it will be subject to government controls and rules just like a bank. In other words, Circle fully complies with all current requirements and will do so.
The U.S. announced the Stablecoin Reserve Transparency and Uniform Secure Transactions Act of 2022, or the Stablecoin Trust Act for short, outlining how the country’s various regulators will deal with businesses that issue cryptocurrencies whose prices are pegged to the U.S. dollar or other assets.
“Payment stablecoins” will be defined in the discussion draft of the legislation, the Office of the Comptroller of the Currency (OCC) will be authorized to develop new licenses specifically for stablecoin issuers, and allow insured depository banks to issue payment stablecoins, as well as state Regulatory oversight in this area of the cryptocurrency industry will be addressed.
On July 20, 2022, the UK government will conduct a first reading of the Financial Services and Markets Act.The 335-page measure claims its main objective is to “provide the regulation of financial services and markets; and for related purposes.” However, the bill emphasizes the need for “digital settlement assets”, which are not yet defined in the law. The new term implements laws and regulations that are fundamentally relevant to the blockchain community and individuals using digital assets.
The term “Digital Settlement Asset” (DSA) is used throughout the legislation and is defined as a digital representation of value or rights, whether or not they are cryptographically protected:
- Adopt technology that supports data collection or storage,
- may be shared, saved or exchanged electronically,
- and can be used to fulfill payment obligations (which may include distributed ledger technology).
The UK government intends to gradually regulate this area. It now aims to change the current regulatory framework for electronic money and payment systems, bringing actions that facilitate the use of certain stablecoins (when used as a method of payment) within the scope of UK regulation.
Given that the bill has just had its first reading recently, and a second reading is scheduled for a hearing in Parliament on September 7, 2022, it may take some time before it becomes the main law in the UK. After the second reading, it will be sent to a committee for assessment and report before returning to parliament for the third and final reading.
The Monetary Authority of Singapore (MAS) strongly encourages the creative use of crypto tokens in value-added use cases. As a forward-thinking regulator, MAS’s focus on CBDC projects as early as 2016 is proof of this.
The Payment Services Act 2019 applies to stablecoins, which may be classified as “digital payment tokens” (PSA). Fiat-backed stablecoins tied to monetary value may fall under the PSA’s definition of “electronic money.”
Businesses regulated by the Monetary Authority of Singapore can use stablecoins in Singapore. They must not be advertised to the public, but may be marketed or promoted on commercial websites, mobile apps or social media accounts.
Stablecoins don’t exist in a vacuum; in addition to competing with more volatile crypto assets like Bitcoin, they also compete with national fiat currencies. The success or failure of central banks to control their own currencies will undoubtedly affect the future of stablecoins and cryptocurrencies.
However, stablecoins do not only provide strong competition in currencies and currency markets. Digital assets, including stablecoins, are ushering in a new era of monetary innovation and inspiring established organizations such as central banks to re-examine one of our oldest institutions, the nature and potential of money, and its function in the financial system.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/how-can-stablecoins-counteract-terra-tornado-cash-and-ethereum-merger/
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