Can Stablecoins Get Past Their Instability?

This post is part of Consensus Magazine’s Trading Week, sponsored by CME. Rajeev Bamra is a senior vice president and head of DeFI and digital assets at Moody’s Investors Service.

Stablecoins, cryptocurrencies designed to hold a stable value through a peg to an underlying asset, such as the U.S. dollar, have gained popularity for their potential to provide the flexibility of cryptocurrency without its price volatility. Their design — whether fiat-backed, as most are, or algorithmic (i.e. backed by other assets or cryptocurrencies) — is meant to offer users a refuge from the price gyrations of traditional cryptocurrencies like bitcoin [BTC] and ether [ETH].

One significant advantage of stablecoins is their operational efficiency and cost-effectiveness in cross-border transactions. Stablecoin transactions can take place with far fewer intermediaries than are involved in traditional bank transfers, for example, making them cheaper and faster to use for sending remittances abroad.

However, although such use cases are promising, stablecoins have not always lived up to their promised stability. In recent years there have been several instances of price depegging, when stablecoins fell below the value of their referenced assets.

See also: USDC Stablecoin Depegs From $1; Circle Says Operations Are Normal

These depegging events have been driven by a range of factors, including regulatory actions, security breaches and imbalances in digital asset pools supporting decentralized exchanges. Investors have responded by divesting their holdings, citing a lack of transparency in underlying reserves and the allure of higher yields from traditional assets in a rising interest rate environment.

Below is a closer look at how several events, as well as changing market conditions, have led to flows away from stablecoins:

• Terra: risk of unregulated stablecoins. The collapse of the algorithmic stablecoin, UST, on the Terra network in 2022 showcased the risks associated with unregulated stablecoins. The dramatic fall in UST’s value had a cascading effect on tether (USDT), the largest stablecoin, causing it to temporarily trade below its $1 peg. UST’s reliance on market anticipation and demand for both LUNA and UST left it vulnerable to market fluctuations.
• FTX: risks from links to traditional finance….