BinanceUSD (BUSD) flipping for third place on the TeraUSD (UST) market capitalization list did not last long. The once-powerful stablecoin that powers the entire Terra ecosystem finds itself short in tweets “Tera is higher than UST”. While no one knows for sure whether LUNA may make a comeback, UST will certainly go down as one of the algorithmic stablecoins that moved in a similar fashion to Basis Cash – which Terra creator Do Kwon alleged. There was typically a part- and Mark Cuban-backed iron finance.
The failure of UST raises the question, are algorithmic stablecoins really doomed to fail? And, are fiat-backed or crypto-backed stablecoins the only way investors can find the most “stable” way to protect themselves from the volatility of the crypto market?
Advantages and disadvantages of different stable coins
By now, most people are aware of the types of stablecoins such as fiat-backed stablecoins, crypto-collateralized stablecoins, and algorithmic stablecoins. There are also other types of stablecoins such as commodity-backed and seigniorage, but the three mentioned above are the most popular.
Users have their reasons for preferring one type of stablecoin over another. For example, some prefer to use algo stablecoins because of their decentralized narrative. Others will go for fiat-backed cryptocurrencies such as Tether (USDT) and USD Coin (USDC), even if they are centralized due to private firms maintaining an equal fiat reserve for each token issued. Nevertheless, one advantage of fiat-backed coins is that there is a real asset backing the coin.
The stability of its peg shall be maintained as long as there are verifiable holdings of such fiat reserves. Still, the most obvious risk here is the scenario of a bank run, which could be difficult for Tether considering how it is largely exposed to commercial paper. Commercial papers are issued by large corporations and are a type of unsecured loan that can have a maturity of more than 270 days. A large number of redemptions could bankrupt Tether, which is why it has slashed its commercial paper holdings over the past six months.
On the other hand, crypto-collateralized stablecoins such as Dai (DAI), are backed by an additional supply of another cryptocurrency, in this case Ether (ETH). DAI requires a minimum collateral ratio of 150%, which means that the dollar value of ETH deposited in smart contracts must be at least 1.5 higher than the value DAI borrows. For example, for a user to borrow $1,000 worth of DAI, they would need to lock in $1,500 of Ether. If the market cap of Ether drops to the point where the minimum collateral ratio is no longer met, the collateral is automatically paid back into the smart contract to liquidate the position.
UST. case of
Stablecoins are, of course, meant to keep their value on their peg. However, what happened with UST was remarkably unprecedented and even threatened the collapse of the entire market. UST is a hybrid between an algo stablecoin and a crypto-collateralized stablecoin. When the price of UST moves above its dollar peg, users are encouraged to burn $1 worth of LUNA for UST to sell at a profit. When UST falls below PEG, users can burn UST in exchange for a discounted Luna. Since the Luna Foundation Guard obtained a large amount of bitcoin (BTC) collateral as a contingency plan, it became crypto-backed. This, as it turned out, was ineffective, and was the last few holdings of BTC and other assets. allotted as compensation to small farmers
Terra’s downfall began on May 8 with a major takedown on Anchor Protocol. Millions of USTs were taken out of the protocol and quickly sold, leading to a downward spiral. What happened was more panic. The algorithm ultimately could not respond quickly enough – burning Luna – to the rapid decline in the value of the UST.
In the end, the evidence was clear as UST’s primary demand was derived solely from the demand for Terra’s Anchor Protocol. The low trading volume of UST suggests that users are more interested in holding the protocol than actually using it for trading.
DAI held steady
Amid the panic, DAI actually remained relatively stable as Tether lost its peg against the US Dollar. At one point, USDT dropped to around $0.994 on May 9, while DAI rose to $1.001. DAI has recently been hailed as the “real” decentralized stablecoin.
Having existed since 2017, DAI has survived many extremes in the market, which no algo stablecoin has ever managed to do. Nevertheless, risk can never be lacking, especially in the crypto market.
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