Stablecoins: Can They Be Trusted?
Deep dive into the LUNA/UST collapse & the future for stablecoins
Dear Sunday Investors:
Welcome to this week’s edition of the Sunday Investor! To our new members, the format of this weekly newsletter will be a deep-dive into one investment-topic. This week, we will be going into stablecoins. We will start by sharing more on what a stablecoin is, the difference mechanisms that have been used to create a stablecoin, as well as different ways you can utilize stablecoins in the cryptocurrency market.
Read, enjoy and share with any friends. Let’s build wealth together.
Weekly Market Recap
Stablecoin UST and Luna Plunge to 0 - WSJ. More on this later, but top 10 coin LUNA plunges 99.9% in one week ($90 to .001) and its algorithmic stablecoin UST drops to a low of .09 from $1, leaving investors stunned.
Rapid Pace of Inflation Eased Slightly in April - WSJ. The Labor Department reported that CPI rose 8.3% YoY, a deceleration from an 8.5% annual rate in March, but higher than the 8.1% YoY economists' estimates.
Elon Musk puts Twitter Deal on Hold - Twitter. Elon tweeted the deal is on hold pending details supporting the calculation that spam/fake accounts represent under 5% of users causing Twitter stock to tank 25%.
Casino stocks rise as the gambling industry reports over $5B in revenue in March - WSJ. U.S. casinos reported $5.31 billion in revenue in March, the highest monthly revenue in the industry's history.
What Are Stablecoins?
After seeing what happened this week with LUNA and UST (more on this later), lets take a step back and learn more about what stablecoins are and how an investor can research them before investing.
Stablecoins are an asset class in crypto which are designed to combine the stability of a typical currency like the U.S. Dollar while also having the ability to trade quickly online like Bitcoin using the power of blockchain technology. The use of stablecoins have been exponentially increasing because they offer investors the best of both worlds being a “volatility-free” option in the crypto market with near-instant transfer times in a secure manner on the blockchain.
Stablecoins were created for a single purpose: stability. Below are the rankings of the top stablecoins by market cap which currently accounts for over $161 billion:
Is regulation around stablecoins coming?
Just this week, U.S. Treasury Secretary Janet Yellen told a Senate banking panel that the turmoil in crypto markets illustrated the need for an "appropriate regulatory framework”. See below:
The SEC's chair, Gary Gensler, has also said that the agency should address stablecoin risks as the asset-linked cryptocurrencies raise concerns related to financial stability and monetary policy around features that are similar to and potentially compete with bank deposits and money market funds. Regulation around stablecoins and crypto will continue to be top of mind in the coming months especially with the UST collapse this week.
Breakdown Of The Different Types of Stablecoins:
Centralized Fiat-Backed Stablecoins (USDT, USDC, BUSD, GUSD):
Centralized stablecoins are the first and most common category of stablecoins in the crypto markets. USDT was the first stablecoin that began trading on Bitfinex exchange back in 2015. Because it was the first stablecoin in the market, it had a strong first-mover advantage which has made it consistently the #1 most used stablecoin on the market, and commonly used for trading pairs on the largest crypto exchanges.
Tether and other centralized stablecoins maintain their $1 peg through a 1:1 collateral system. They do this by holding cash in their reserves which are equal to the amount of stablecoin that is issued out to the open market.
Example: If an issuer like USDT or USDC has $100M in fiat currency in their reserves, then they should only be able to distribute $100M in stablecoins.
The controversy has intensified over recent years into how these centralized crypto companies are audited and tracking their reserves. USDT or Tether has been in the news numerous times over the years for their non-transparent issuance process of USDT tokens. In March of 2019, Tether changed their website which initially said its USDT token was 'backed 1-to-1 by traditional currency' to add cash equivalents, receivables from loans, and other assets to its reserves. Just last year, it was released that Tether will pay $41M to settle allegations that it lied in claiming USDT was fully backed by fiat currencies, which seemingly puts this behind them.
With USDT, USDC, BUSD, and GUSD as some of the largest stablecoin assets that investors already use daily to trade on popular exchanges like Coinbase, we know that they will not be going anywhere in the future. Regardless, it is important to do your own due diligence on any investment in stablecoins.
Fiat-backed stablecoins are known as the safest stablecoins as they are backed 1:1 by USD or bond equivalents and have monthly attestation reports to provide transparency in the coins backing. Check USDC’s here.
Buy Centralized Stablecoins and Earn 8-9% APY in Interest:
Use a Crypto Exchange like Voyager, or Gemini to exchange your fiat currency into fiat-backed stablecoins like USDC and GUSD. On all of these crypto exchanges listed above, you are able to hold your stablecoin for 8%+ APY. I currently use both of these platforms to hold stablecoins that earn interest every month as the current rates of 9% on Voyager exponentially beats Marcus by Goldman Sachs, the best high yield savings account on the market at 0.60%.
Use code CHRBGO on Voyager when making an account for $25 in Bitcoin when you sign up!
Decentralized Stablecoins (DAI, FRAX, UST):
Decentralized stablecoins are backed by a crypto-asset such as Ethereum rather than fiat currencies in centralized versions. The prominent player in the game here is DAI which was made as one of DeFi’s first attempted to make a decentralized “Central Bank” in crypto.
Instead of relying on a centralized issuer to back assets like Tether or USD Coin, decentralized stablecoins rely on the technology of smart contracts to accomplish this. Instead of being supported by an equivalent amount of currency off-chain, DAI tokens are propped up by overcollateralized debt denominated in Ehereum.
For example, if you want to buy $10,000 worth of DAI stablecoins, you would need to deposit $20,000 worth of ETH which equates to a 200% collateralized ratio. You have to do this because the excess collateral buffers DAI’s price in order for it to maintain stability and keep its peg at $1. However, if the ETH price substantially drops below a set threshold to your liquidation zone, your collateral is paid back into the smart contract and your position is liquidated.
The two challenges with decentralized stablecoins like DAI are how the current methods of over-collateralization limits capital efficiency, making it difficult for DAI to scale with demand; Another is how the current arbitrage tactics used to keep the price of DAI at $1 requires substantial capital than other centralized stablecoins.
Demand will continue to rise for decentralized stablecoins, so it will be interesting to see how Maker (the creator of DAI) or others will address the potential shortfalls listed above.
Commodity-Backed Stablecoins (PAXG, XUAT):
Commodity-backed stablecoins are essentially blockchain-based representations of commodities and are backed by reserves held by a central entity. The most popular commodity to be collateralized is gold as Tether Gold (XAUT) and Paxos Gold (PAXG) are two of the most liquid gold-backed stablecoins on the market.
It is important to note that these commodities such as gold fluctuate in price, so these assets do not have a constant 1:1 peg to the U.S. Dollar like the other categories of stableassets we have discussed.
Holders of XAUT or PAXG are also both able to trade their tokens for cash on the open market, or they are able to redeem their tokens for physical gold at specified locations as well. For many, holding physical gold or silver bars is not always a practical option, so these stablecoins give investors more flexibility if they want to invest in these other asset classes.
Examples of commodity-backed stablecoins: Tether Gold (XUAT), Paxos Gold (PAXG)
Algorithmic Stablecoins (AMPL, BAC, USDD, UST):
Algorithmic stablecoins are a newer and more experimental version of stablecoins. As their name mentions, instead of using fiat or cryptocurrency as collateral, their price stability happens from a combination of specialized algorithms and smart contracts that automatically manage the supply of tokens in circulation. UST was the most popular example of a algorithmic stablecoin… more on this later.
Another popular algorithmic stablecoin is Ampleforth (AMPL). The entire circulating supply of AMPL is either automatically increased or decreased every 24 hours to ensure that the AMPL token stays at $1. If the price of AMPL is trading 5% or more above the $1 target, it will cause an expand of supply to AMPL holders and if the price is trading 5% or lower than $1, then the supply will decrease.
There are many ways that the algorithmic stablecoin market is evolving and it will be important to see the developments of similar tokens in this niche throughout the next year.
Examples of algorithmic-backed stablecoins: Ampleforth (AMPL), TerraUSD (UST), TronUSD (USDD), BasisCash (BAC)
What Happened with TerraUSD (UST)?
Being in crypto for 6+ years, I have not seen anything quite like the Luna/UST catastrophe this week.
Luna, which was a top 10 cryptocurrency and tied to TerraUSD (UST) fell from $85 at the beginning of the week to $.0001 which is over a 99.9% fall in less than one week. It’s stablecoin fell from its peg at $1 to under 0.10c. LUNA and UST were top 20 tokens by market cap in the entire cryptocurrency market so the question is how did something like this happen?
To read in depth on the events day by day this week, head to this twitter thread which explains the events of the week; if not, the TLDR will be right after it:
tldr:
Attackers borrow 100,000 Bitcoin from centralized exchange Gemini ($3B)
Attackers drain liquidity on the largest decentralized exchange for stablecoins in Curve causing zero liquidity and the start of the depegging from $1
650M of UST is brought over to Binance to sell causing $UST price to drop even further
Rumors start to go around about this happening; now everyone is desperately selling $UST on exchanges driving the price down even further
The Luna Foundation tries to bring the peg back to $1 by buying $UST and selling massive amounts of Bitcoin… but its too late
$UST Sell-Off = More $LUNA in circulation = Lower LUNA price: $LUNA and $UST continue to fall as the domino affect begins
Panic sits in: $UST falls to under $0.50, LUNA falls over 60% in days awaiting the leader of $UST, @stablekwon’s, master plan to “announce a recovery plan”.
Recovery plan never succeeds(was there even one?), $LUNA drops over 99.9% to under .001 and UST drops down under .10.
What’s next for Terra? Nobody knows exactly but there is a rebuild of the ecosystem on Terra that is beginning as well as massive shift of builders onto other blockchains after the catastrophe this week. One lesson to learn is that no coin is too big to fail proven in instances like $LUNA and $UST.
Memes Of The Week
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Will be keeping my eye out for new content to write about these next few weeks. Be sure to send in any questions directly to me or comment below on this post what you’d like me to write about or answer next!
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Not financial or tax advice. The content in this newsletter is for informational purposes only. Every investment and trading move involves risk. Do your own research when making a decision.