Some cryptocurrencies have always been quite volatile, with values soaring or plummeting in a short space of time. So for the more cautious investor, ‘stablecoins’ were considered the sensible place to go. As the name implies, they are designed to be a more stable and secure bet.
At the moment, however, that stability appears to be difficult to find. The value of one of the most popular stablecoins, Terra (aka UST), has fluctuated wildly over the past few days, before falling dramatically – and is still to be recovered†
Before the crash, Terra was in the top 10 crypto assets, valued at more than $18.7 billion. At the time of writing this had collapsed to less than $7 billion†
Investors have the social media to regret this development. Some spoke of lost savings and the devastating effects of the collapse of the currency.
And they are right to be concerned. The impact of volatility in the stablecoin arena should not be underestimated and could destabilize the entire sector.
In theory, stablecoins should offer the transaction benefits of more traditional crypto assets (such as Bitcoin), but with a predictably stable value.
Many stablecoins are backed by other assets (usually the US dollar) or commodities (often gold), and the stablecoin provider buys – and then holds – the equivalent amount of their chosen assets to ensure the currency remains stable. So while the value of the underlying may go up or down, the value of the stablecoin should at least stay in a consistent ratio with whatever underpins it.
But “algorithmic stable coins” like Terra work differently† Terra has no reserve assets or commodity and instead aims to maintain its value using an algorithm designed to maintain a balance between the stablecoin and a partner coin (a more traditional cryptocurrency).
In this case, Terra is linked to a partner coin called Luna – and Luna’s value crashed. The value is now less than US$0.06 traded at about US$82.00 just seven days earlier. In a climate where the value of Terra and Luna are both falling drastically, the algorithm can’t solve the problem of declining confidence in the paired currency – and the stabilization feature just doesn’t work.
As a result, fear sets in and more people sell, just like a traditional bank run, where massive cash withdrawals and a sudden drastic loss of value occurs. Asset-backed stablecoins tend to avoid this, due to the long-term stable value of their peg which builds consumer confidence.
But they also have problems. Tether, a currency pegged to the US dollar, has bumps in the road amid questions about whether the company issuing the coins has the reserves claims to have† And in the past few days, Tether has also been depreciation†
Save the savings
All of this undermines the premise of these coins – that they will remain stable. Customers choose to buy them either to protect against volatility in traditional crypto markets until they rise again, or to use them as a more traditional account (such as a regular bank account) and take advantage of the benefits they offer in terms of speed , costs, and ease of international transactions.
But investors with their money in Terra have seen their savings fall by about half. The fact that it has still not stabilized does little to alleviate the concerns. In simple terms, the potential for a cryptocurrency crisis is very real.
That is why the approach of governments worldwide must change. While much has been said about regulation in the United Kingdom and The United Statesthere has been little meaningful action.
If they don’t act, it will be difficult to advocate the use from stablecoins as they continue to expose consumers to the volatility and risk they are supposed to avoid.
The time to give the sector freedom to innovate seems to be over. Regulation is essential – to provide consumer protection and prohibit excessively risky practices – if the potential of stablecoins is to be realised. That potential is something that many feel can revolutionize the global economy, speed up transactions, lower costs and increase transparency.
But giving the sector the opportunity to innovate should not come at the expense of people’s savings. If withdrawals continue, it will test both the stability of a particular stablecoin, and more broadly, whether the entire industry has a future. A stable currency struggling is bad news. But two or more can be catastrophic for customer confidence.
Article by Matthew ShillitoLaw Teacher, University of Liverpool
This article was republished from The conversation under a Creative Commons license. Read the original article†
