Stablecoins: The essential but controversial bridge between crypto and stability

SO WHAT? A Web3 Digest for Executives

Must-know news and analysis from Web3 for busy executives. Brought to you by Terminal 3. Co-authored by Jon Russell and Gary Liu.

Stablecoins: The essential but controversial bridge between crypto and stability

Stablecoins are the most-traded crypto assets but shrouded in uncertainty and major targets for regulation

Jon Russell and Gary Liu

Feb 14, 2024

This week’s issue is the final in our series into how the Web3 space is maturing in 2024. We previously looked in detail at the arrival of US ETFs and the trillion-dollar opportunity of RWA (Real World Assets). Up next is stablecoins.

These are hugely influential assets that will play a massive role in the future of Web3. Tether, the world’s top stablecoin, is traded more than any other crypto asset and its value combined with the number two stablecoin (USDC) is approximately US$125 billion.

We’d like to wish a Happy Lunar New Year to all of our readers, may the Year of the Dragon bring you prosperity!

What’s going on?

Cryptocurrencies may be about stoking the ideal of retiring from a single trade, but one of the key pieces of the industry is far more mundane: stablecoins.

These digital assets are pegged to the US dollar or other fiat currencies to ensure that they provide stability for your money. But the spectacular implosion of Luna nearly two years ago—which liquidated tens of billions in assets—plus the shady uncertainties of today’s largest issuer of stablecoins means there’s still plenty of concern.

There will soon be a day when you can simply swap your fiat currency for a stablecoin with your bank directly. But, for that to happen, expect plenty of regulation and a lot more clarity.

SO WHAT?

1. Anchors in a sea of volatility

They may not be sexy or exciting, but stablecoins are an essential bridge between the volatile world of cryptocurrencies and the stability of traditional fiat currencies. Unlike Bitcoin, Ethereum, or other cryptocurrencies that can see values wildly in short periods, stablecoins aim to maintain a steady value—typically mirroring fiat currencies like the US dollar.

Traders use them as dry powder storage between trades, and they are essential landing mats for on-ramping and off-ramping fiat currencies into digital assets. But not all stablecoins are created equally:

2. Instability and lack of transparency but huge profits

Stablecoins underpin the entire crypto ecosystem, but they are not without controversy. The aforementioned Terra (and Luna reserve asset) showed the havoc wreaking that occurs when stablecoins don’t work.

Stablecoin TerraUSD (UST) was backed by Luna and a yield scheme that incentivized Luna holders to deposit the sister token for a high annual yield of 20%. When $2 billion UST was unstaked on 7 May 2022, the stablecoin depegged. The ensuing rush of users offloading UST and Luna saw both prices crash. That set off a chain reaction that saw investment firm 3 Arrows Capital, crypto lender Celsius Network, and FTX among the institutions brought to their knees.

Tether, currently the world’s highest-traded stablecoin (USDT), hasn’t crashed and burned like Luna but there are still continual questions around its back and reserves. Tether claims USDT is “pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether's reserves” but it is still to produce indisputable proof. It said last year that it plans to publish its reserve data “in the coming years.”

Despite the opacity, Tether claims to be hugely profitable with a $2.85 billion profit in Q4 2023. We will likely learn a lot more about the business when Circle, issuer of second largest stablecoin USDC, goes public in an anticipated US IPO this year. USDC depegged last May—going as low as $0.87—in the wake of Silicon Valley Bank’s collapse, but to Circle’s credit it quickly regained its $1 price.

3. Regulation is challenging but coming soon

Stablecoins will undoubtedly become more mainstream as adoption of Web3 grows, such is their importance, and regulation is very much on the cards.

The US is expected to pass stablecoin regulation this year. U.S. Treasury Secretary Janet Yellen has argued that federal regulators should gain oversight, rather than allowing state-level authority. While that uncertainty plays out, other countries have taken up the mantle.

Japan last year introduced stablecoin regulation which asserts that only banks, trust companies and fund transfer services can issue stablecoins in order to ensure that they are backed with requisite reserves. Foreign entities would need to find a local partner. Hong Kong has also proposed regulations that would require a license and implements conditions for management of reserves, customer due diligence and more.

Singapore, often a pioneer in digital asset and blockchain programs, issued a regulatory framework last year which allows stablecoins pegged to the Singapore dollar or any G10 currency to be issued from Singapore.

Critical to the future

Stablecoins represent a crucial piece of the cryptocurrency ecosystem, offering stability and utility in an otherwise volatile environment. The collapse of Luna—and the domino fall it set off—shows why regulators are keen to introduce minimum standards, but getting already dominant and opaque players like Tether to comply won’t be easy. Regulatory clarity and transparency is essential to ensure the long-term viability and stability of stablecoins and, by extension, the entire Web3 market.

News Bytes