Understand how Stablecoins have fared in the Crypto Bear phase

Cryptocurrencies have long been considered a hedge against inflation and a better alternative to fiat currencies that are prone to devaluation problems. Most cryptocurrencies have clearly underperformed their stock market benchmarks due to liquidity pressures caused by the tightening of monetary policy by leading central banks such as the US Federal Reserve.

Aimed at curbing record inflation numbers being reported on the world’s largest economy, the quantitative tightening has seen both stock and cryptocurrency prices correct significantly from their peaks and is eerily reminiscent of the bear cycle of 2017.

Are Stablecoins Really Stable?

While stablecoins such as Tether USDT/USD and USD coin USDC/USD has recovered from being depegged from the US dollar, the Terra UST/USD crash has upended the belief that stablecoins are stable after wiping away billions of dollars of investor capital.

Although USDT and USDC contribute to almost 80% of the stablecoin market, the panic caused by the UST crash caused USDT to lose more than $10 billion in market capitalization, while USDC benefited greatly with its market share rising from 27% to 34% in aftermath.

Issued on a 1:1 basis with US dollar collateral, these tokens have now stabilized near the $1 mark as their issuers took steps to secure additional collateral to offset further selling pressure from jittery investors.

Overcollateralized Stablecoins exposed to liquidity risk

On the other hand, overcollateralized stablecoins such as Day DAI/USD, Magic Internet Money MIM/USD and Liquidity USD LUSD/USDwhich use non-stablecoin cryptocurrencies such as Bitcoin BTC/USD and Ethereum ETH/USD as collateral, remain exposed to liquidity risk caused by falling prices of these leading cryptocurrencies.

Since these overcollateralized stablecoins use BTC, ETH or other derivative assets as collateral, the extra margin needed to keep the US dollar peg has a tendency to exert further downward pressure on the underlying cryptocurrency.

This can eventually set off a domino effect, as was well demonstrated by the UST crash.

While the exact mechanism of the UST crash is a bit more complex, it is clearly clear that stablecoins have a long way to go before they can win back investor confidence.

Some stablecoins like USDD USDD/USDissued by Tron and whose primary activities are managed by the TRON DAO Reserve, have shown better stability, while delivering a 30% interest rate to investors staking stablecoin.

However, a large part of this strength is the fact that retail investors can only trade the USDD stablecoin on the secondary market, while all other activities such as token issuance, burning and management are attributed to TRON DAO Reserve’s approved whitelist rather than the underlying algorithm. .

Innovative ways to maintain the USD peg

Another approach can be seen with FRAX stablecoin, touted as the world’s first fractional algorithmic stablecoin by its creators, which uses USDC as collateral and Frax Del FXS/USD as a value accrual and governance token that remains volatile by design.

Offers better stability than fully algorithmic stablecoins such as UST or TerraClassicUSD USTC/USD in its new avatar, FRAX is an example of how crypto entrepreneurs are experimenting with innovative ways to maintain the US dollar peg with more stability.

Stablecoins promote DeFi expansion

Although often chosen based on the profitability offered due to incredible interest rates, stablecoins are increasingly promoting the expansion of the decentralized finance (DeFi) space and will continue to attract more protocols fighting to take advantage of the vacuum left by the UST crash.

While the jury is still out on how the entire basket of stablecoins navigates through the current crypto bear period, further price corrections could seriously undermine the very foundations of these virtual assets.

Governments reviewing regulations

Recognizing the need for immediate regulation to avoid a repeat of the UST debacle, financial regulators in the US and UK markets are already considering legislative changes to ensure that existing legal frameworks can contain the risks associated with the failure of such firms issuing stablecoins.

Whether issuers will have to secure their stablecoins with tangible assets instead of other stablecoins or cryptocurrencies in the future is still a matter of speculation, both innovation and regulation will be needed to ensure that stablecoins can survive the test of time and prove their worth in a Web3 dependent world.

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