Why in News:
- Recently, the Financial Stability Board (FSB), a body which advises major economies on international finance, promised to push for stablecoin regulation, citing “recent turmoil” in the cryptocurrency market.
- In May 2022, Tether lost $10 billion in market capitalization in the wake of the Luna Terra ecosystem’s implosion and the crash of the third-largest stablecoin, terraUSD (UST), to near zero from its dollar peg
What are stablecoins?
- A stablecoin is a digital currency whose value is pegged to a ‘stable’ asset, such as the U.S. dollar or gold.
- The best-known stablecoin in the crypto ecosystem today is arguably Tether (USDT), whose market cap is close to $66 billion, putting it below Ethereum, the second largest cryptocurrency in existence.
- 1 USDT is meant to be worth 1 USD, though market factors can take prices slightly above or below this mark. Other stablecoins such as USD Coin (USDC) and Binance USD (BUSD) are also pegged to the U.S. dollar. Tether also recently launched a stablecoin pegged to the British pound.
- Stablecoins are not authorised for use by a country’s lawmakers or central bank. That means investors take on considerable legal and financial risk to hold them.
What roles do stablecoins play in the crypto ecosystem?
- For a cryptocurrency trader, tracking stablecoin flows can help them gauge the state of the market, or even make educated guesses about future cryptocurrency price movements.
- For example, when the stablecoin supply on crypto exchanges spikes, it might be a sign that investors are cashing in their stablecoins to buy cryptocurrencies such as Bitcoin (BTC), Ether (ETH), or even other alt coins.
- Many traders believe this can lead to upward price moves. On the other hand, if the stablecoin supply on crypto exchanges suddenly drops, one might conclude that traders are buying these relatively steadier assets. This could mean traders want to hedge against future risk and volatility, or are driven by fear.
What are the use cases for stablecoins?
- In countries such as Turkey, Nigeria, and Argentina where the local currency is rapidly losing value, converting funds to stablecoins is one way for residents to try and safeguard their earnings.
- In Taliban-occupied Afghanistan, with remittance channels choked by American sanctions, stablecoin transfers helped a few crypto users live to see another day. For this reason, a large section of the crypto community does not want stablecoins to be controlled by centralised laws or standards.
How ‘stable’ are stablecoins?
- Stablecoins are only as stable as their investors’ faith in the peg. For example, Tether has been taken to the American legal system as investigators struggled to ascertain whether the top stablecoin company really backed every USDT against a U.S. dollar. This type of peg is called a “fiat collaterised” stablecoin.
How is the Terra fallout linked to stablecoins?
- TerraUSD (UST) is an algorithmic stablecoin. It is linked to another token’s supply. The other cryptocurrency, LUNA, is adjusted to help UST maintain its peg.
- This method of linking with another token helps keep crypto firms from buying reserve assets such as dollars or crypto or even gold.