After 7 years, why are stablecoins once again at the center of attention?

Original title: "Why are stablecoins at the center of the storm again?" Author: Rance Yue & Eli Tan

Stablecoins have been around for about seven years, but discussion about them has never been as heated as in recent weeks, not only in the cryptocurrency space but also among regulators and traditional market investors.

What are stablecoins?

A stablecoin is a cryptocurrency whose value is usually anchored to another asset, whether it is a government-issued currency (such as the US dollar), a precious metal (such as gold), or even another cryptocurrency.

Stablecoin issuers have been trying different methods to achieve and maintain the peg of stablecoins to the price of their underlying assets. Some stablecoins are pegged to the US dollar, such as USDT, USDC, BUSD, and GUSD, and the value of the US dollar in their reserves should match their circulating supply; others are backed by physical commodities, such as each Tether Gold (XAUT) value token represents 1 ounce of London Good Delivery gold.

In addition, there are decentralized stablecoins such as DAI and FEI, which are driven by algorithms.

How are stablecoins used?

Before the rise of stablecoins, most people used cryptocurrencies to trade with fiat currencies and other cryptocurrencies. Pankaj Balani, CEO of crypto derivatives exchange Delta Exchange, pointed out: "Starting in 2017, spot trading for stablecoins began to account for a larger share of trading activities."

Stablecoins offer a faster, cheaper alternative to trading cryptocurrencies for fiat currencies, allowing for more liquidity. In theory, they are also less susceptible to market price swings in other cryptocurrencies.

Stablecoins are also being used for crypto lending. For example, you can earn 4% annual interest on USDC by depositing it in a savings account at Coinbase, one of the companies behind the stablecoin. Depending on the platform, the interest rate for depositing USDT ranges from 1.66% to 13.5%.

There’s been a lot of talk about stablecoins lately, some of which can be overwhelming. Here are three of the big ones happening right now:

1. Tether is under suspicion

As the most traded cryptocurrency on the market, USDT has become the backbone of the entire cryptocurrency ecosystem. The current value of USDT in circulation is about $62 billion, supporting more than half of Bitcoin transactions.

Above: Market capitalization of several major stablecoins. Source: CoinMarketCap

However, Tether, the company behind USDT, has been plagued by regulatory issues.

On Monday, Bloomberg reported that the U.S. Department of Justice is investigating whether Tether concealed cryptocurrency-related transactions from banks in its early days. One of the features of Tether (USDT) is that its issuing company claims that each USDT token is backed by assets worth one dollar, which are either real currencies or assets including commercial paper, corporate bonds and precious metals. This has raised concerns that if many traders sell USDT at the same time, the assets supporting the token may experience a run.

Tether responded on its website, saying the Bloomberg article was based on "allegations from years ago and is clearly intended to generate clicks." However, the company did not explicitly deny the allegations.

Tether (USDT) was first released in 2014 to solve a problem that plagued the cryptocurrency market at the time: banks did not want to open accounts for virtual currency exchanges because they were worried about being exposed to funds related to drug smuggling, cyber attacks and terrorism. By accepting Tether (USDT), exchanges are able to allow traders to hold assets without being affected by Bitcoin's price fluctuations, and funds can be transferred from one exchange to another instantly.

However, as mentioned earlier, some investors are uneasy about the reserves that back Tether (USDT) issuance, questioning the company's ability to redeem tokens in the face of a worst-case scenario. In May, the company disclosed a breakdown of its reserves as part of a settlement with the New York Attorney General's office. According to Tether, about 50% of its reserves are invested in "commercial paper" (usually short-term corporate bonds), 13% in secured loans, and 10% in corporate bonds and precious metals.

Economist Frances Coppola said that the commercial paper, loans and corporate bonds held by Tether are subject to market risk, maturity risk and credit risk. "If the value of the commercial paper or corporate bonds they hold goes down," Coppla said, "then the value of the tokens they issue will not be $1, but less."

2. Regulatory pressure

According to CoinMarketCap, as of July 26, the total market value of stablecoins was $116 billion, an increase of nearly 4 times since the beginning of the year. With this growth, the attention of U.S. and other regulators on stablecoins has also increased.

Alex Svanevik, CEO of crypto analytics firm Nansen, said: "Regulators are paying attention to stablecoins because they are closer to the existing banking system than other types of cryptocurrencies. Stablecoins have the potential to disrupt traditional finance."

A month ago, Eric Rosengren, president of the Federal Reserve Bank of Boston, identified Tether and other stablecoins as a systemic risk and expressed concern that short-term credit markets could be disrupted.

Additionally, U.S. Treasury Secretary Janet Yellen said regulators must “act quickly” to consider new rules for stablecoins, and that she would study the regulation and risks of stablecoins as part of a presidential advisory group. Shortly thereafter, officials from the Treasury, the Federal Reserve, the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation met to discuss the issue “given the rapid growth of digital assets.”

Separately, SEC Chairman Gary Gensler suggested last week that some stablecoins should be considered securities and subject to SEC regulation.

In China, Fan Yifei, deputy governor of the People’s Bank of China, reportedly said that digital currencies pegged to fiat currencies make the bank “very worried” and “may bring risks and challenges to the international monetary system.”

3. Circle plans to go public, and other stablecoin issuers disclose more information

Circle, the issuer of the second largest stablecoin USDC, has also attracted attention. Circle plans to go public through a merger with special purpose acquisition company (SPAC) Concord Acquisition. The deal values ​​the crypto financial services company at $4.5 billion.

Following Circle CEO Jeremy Allaire’s promise to increase transparency at the company, Circle revealed for the first time the breakdown of the assets backing USDC in its latest certification on July 16. The company reported that about 61% of its USDC tokens are backed by “cash and cash equivalents,” meaning cash and money market funds; Yankee certificates of deposit (i.e., certificates of deposit issued by foreign (non-U.S.) banks) account for 13%, U.S. Treasuries account for 12%, commercial paper accounts for 9%, and the remaining tokens are backed by municipal and corporate bonds.

Another stablecoin issuer, Paxos, also released the reserve details of its stablecoins PAX and BUSD for the first time. As of June 30, 96% of the reserves were held in the form of cash and cash equivalents, and 4% were invested in U.S. Treasuries.

Image source: Paxos

The systemic role and risks of stablecoins

The systemic role that stablecoins play in cryptocurrency trading and lending has led some investors to worry about worst-case scenarios, such as what would happen if stablecoin issuers faced a massive wave of redemption requests.

The risk could also spread to traditional markets. Credit ratings firm Fitch Ratings said in a report earlier this month that risks facing stablecoins could be "contagious." According to Fitch data, as of March 31, Tether held a total of $20.3 billion in commercial paper (CP), which means that its CP holdings may exceed most outstanding money market funds in the United States, Europe, the Middle East and Africa.

“If a sudden large-scale redemption of USDT occurs during a period of broader selling pressure in the CP market, especially if it is associated with broader redemptions of other stablecoins with similar asset reserves, it could affect the stability of short-term credit markets,” the ratings firm said.

David Grider, head of digital asset research at Fundstrat Global Advisors, said stablecoins may also affect money supply. Actual reserve dollars (that is, the dollars in the reserves that back stablecoins) can be loaned out in the real economy to earn interest, and the issued stablecoins may be loaned out again in the crypto economy, also earning interest. As Grider wrote in an analysis report, this "is actually lending the same dollars twice."

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