Stablecoins

Flatcoiners should take a cue from TerraUSD’s fate

Flatcoins need to provide a more stable and decentralized alternative to traditional currencies — otherwise, they’re nothing but investment vehicles.

The post-COVID-19 era has brought the issue of inflation to the forefront, leading to increasing interest within the Web3 space for creating flatcoins, a close “cousin” of stablecoins designed to mitigate inflation risk.

Many existing flatcoins, like Terra’s TerraUSD (UST) stablecoin, are algorithmically backed and therefore serve as a stark reminder of the risks associated with algorithmic backing, as demonstrated by the collapse of LUNA and UST. So, while the idea behind flatcoins may seem appealing, they raise significant reservations conceptually and in terms of design. Ultimately, the success of flatcoins will depend on whether developers can deliver on their promise.

To date, flatcoin white papers — including the one offered by Coinbase — do not appear to deliver on their envisioned promise, at least in their current state. In particular, the token economics designs of some projects are likely to pose an even higher risk than contemporary stablecoin designs.

Problems at the conceptual level

Examining the potential use cases of flatcoins is indeed crucial. While often presented as an asset that can help users preserve their purchasing power amid inflation and economic uncertainty, this idea could be misleading.

Stablecoins are digitized versions of fiat currencies, and their value as a medium of exchange and unit of account is the same as that of fiat currencies. In contrast, flatcoins are indexes of the buying power of a fiat currency obtained through oracles that collect data on economic indicators such as the Consumer Price Index (CPI).

Related: CBDCs will lead to absolute government control

As a result, the unit value of flatcoins will diverge from the fiat currency they track over time as long as inflation is not zero. Therefore, the existence of flatcoins depends on the assumption that fiat currencies or their digitized forms are the mediums of exchange and units of account.

In other words, there will not be a situation where flatcoins are better than stablecoins or fiat currencies as mediums of exchange and units of account because the existence of flatcoins hinges on the superiority of fiat currencies and stablecoins at these roles.

Inflation-pegged assets already exist

Flatcoins are financial instruments that expose investors to inflation rates, making them a derivative of inflation. Asset classes that expose investors to inflation risk have been around for a long time.

For instance, Treasury Inflation-Protected Securities (TIPS) have been used since 1997 to manage inflation risks tied to fixed-rate bonds. Retail investors can easily access TIPS and gain exposure to inflation through exchange-traded funds (ETFs) in their brokerage accounts.

The availability of these established inflation-linked asset classes through ETFs means that institutional and retail investors can easily manage their exposure to inflation. The potential value proposition of flatcoins as an investment vehicle for inflation hedging may be limited.

Despite some criticisms of flatcoins, they do have the potential to bring value to the economy. The true innovation of flatcoins lies in their integration of traditional financial instruments onto the blockchain. Flatcoins are a digitalization of an existing asset class, similar to how stablecoins digitize fiat currencies. This innovation may allow for more efficient financial transactions and creates competition with traditional financial intermediaries such as TIPS ETFs, potentially leading to greater efficiency and lower costs in financial markets. However, it is essential to recognize that the existence of flatcoins is not the salvation of the macroeconomic challenges we face today.

Design-level problems

Previous discussions revolved around the potential uses and innovations of flatcoins. However, it is essential to note that the current development of an inflation-pegged stablecoin is still in its infancy and faces significant challenges.

A few projects are currently in progress that are developing CPI-indexed flatcoins, but these projects rely on mechanisms similar to stablecoins. Some existing flatcoin designs, such as Frax Price Index Share (FPIS) and Reflexer’s Rai Reflex Index (RAI), algorithmically adjust the supply of the flatcoin to maintain the peg to a specific purchasing-power-related index, similar to how algorithmic stablecoins keep their pegs to fiat currencies.

However, algorithmic stablecoins have proven to be a risky design class, as extreme market conditions can cause a downward spiral similar to a bank run, as seen in the case of Terra’s collapse.

For example, Frax Finance’s white paper on the pegging mechanism of its Frax Price Index (FPI) states:

“During times that AMO yield is under the CPI rate, a TWAMM AMO will sell FPIS tokens for FRAX stablecoins to keep the CR at 100% at all times.”

To simplify, it states that the protocol will sell index tokens for Frax Finance’s stablecoin if the CPI index’s return falls below its actual value. However, this design poses a vulnerability common in algorithmic stablecoins. If the protocol runs out of reserve Frax Price Index Share (FPIS) tokens, a run similar to Terra’s will likely happen.

Additionally, as inflation rarely goes negative, constant sales of FPIS tokens will be necessary to maintain the 100% collateral ratio, making this design even more susceptible to runs than other algorithmic stablecoin designs.

Frax white paper detailing its “stability” mechanism

The tradeoff of relying on something other than algorithmic adjustment is the reliance on centralized authorities. Stablecoin projects that use fiat money as collateral rely on trust in the project to maintain U.S. dollar escrow. In contrast, those depending on overcollateralized crypto assets are subject to market risks. Unfortunately, flatcoin projects still need to provide a solution to this problem.

Another critical barrier to developing an effective purchasing power index with flatcoins lies in the accuracy of the data provided by oracle protocols. Relying on publicly available CPI data published by the Bureau of Labor Statistics alone would limit the true potential of flatcoins. Projects such as Chainlink and (my own) IoTeX’s W3bstream have the potential to provide real-time data that could make accurate and timely CPI data possible.

Related: The world could be facing a dark future thanks to CBDCs

The success of flatcoins will depend on the continued innovation of oracle teams. A decentralized flatcoin index could significantly improve existing investment instruments for hedging inflation risk if creators can achieve real-time CPI data.

Risks and uncertainties

The widespread adoption of flatcoins and similar cryptocurrencies depends on their ability to overcome the inherent challenges and risks of stablecoin designs.

As flatcoins and other inflation-indexed cryptocurrencies emerge, evaluating their impact on the broader financial ecosystem is crucial. Do they provide a more stable and decentralized alternative to traditional currencies, or are they just another investment vehicle?

Investors, users and regulators must carefully examine new developments in the digital asset space. Understanding these cryptocurrencies’ true nature and potential is vital to determining whether they will become dominant in the financial landscape or remain an intriguing but niche investment option.

Flatcoins’ emergence highlights the ongoing pursuit of stability and decentralization in the digital asset arena. Although this new financial instrument introduces an innovative approach, it carries additional risks and uncertainties. Investors, users and regulators can better navigate the future of inflation-indexed cryptocurrencies by maintaining a critical eye on these developments.

Peter Han holds a Ph.D. in finance from the University of Illinois Urbana-Champaign, concentrating in financial intermediation and fintech, in addition to a master’s degree in financial engineering. He holds a BA in English and BS in mathematics from China’s Tianjin University. He worked for PwC in Beijing before joining IoTeX, where his work focuses on tokenomics-related research aimed at enhancing IoTeX’s tokenomics design.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

US needs to regulate stablecoins to keep a strong dollar: Stellar CEO

The United States and the greenback will suffer if stablecoin regulations are not rolled out this year, Stellar Development Foundation’s chief has claimed.

United States financial regulators are tightening their grip on the crypto industry and the U.S. dollar has also been under pressure with countries distancing themselves from dollar hegemony, but the chief of Stellar says stablecoin regulation may solve that.

In an April 11 Bloomberg interview, Denelle Dixon, the CEO and executive director of the Stellar Development Foundation, spoke about the prospects of regulating dollar-pegged digital assets in the United States.

Dixon said she was very optimistic that there would be some form of stablecoin regulation in the U.S. by the end of the year because “they want to set the standard.”

“If we want a strong U.S. dollar globally, a USD stablecoin is the way to see that happen.”

President Joe Biden’s administration has already highlighted the need for a stablecoin regulatory framework, but Dixon said that needs to be pushed through Congress.

“If we don’t do something in the U.S., we’re going to be in this bifurcated world where we have legislation outside the U.S. that’s friendlier to crypto,” Dixon said, adding:

“There will be companies outside the U.S. and there will still be the issue that U.S. consumers will want to leverage this technology.”

Dixon was optimistic about stablecoin regulation “only because we don’t have a choice,” saying the focus should be more on the utility and value to users than on the tech stack.

“Stop talking about the technology and start demonstrating the utility,” she added.

Stellar is a decentralized cross-border payments network powered by the Lumens (XLM) token. It was created as a modified fork from Ripple’s codebase in 2014.

Related: Stablecoins are solution to crypto’s banking problem, exec says

Stablecoins currently represent around 10.5% of the entire crypto market capitalization with $133 billion in circulation. Dixon hinted that it was paramount that stablecoins are regulated and accepted in America as the vast majority of them are pegged to the U.S. dollar.

Market leader Tether (USDT) has issued $14 billion in USDT so far this year, strengthening its market share to 60% with its circulation of $80 billion.

The gains come at the expense of Circle’s USD Coin (USDC) and Binance’s Binance USD (BUSD) stablecoins, both of which have seen considerable declines in supply this year.

Magazine: Unstablecoins: Depegging, bank runs and other risks loom

PayPal and the credit card industry are taking advantage of consumers

Stablecoins offer a way for consumers — particularly Americans — to escape the financial industry’s punitive transaction fees.

As rising prices have forced consumers all over the world to reduce their spending and find new ways of coping with the increased cost of living, consumers are finding themselves relying on credit cards even more than they already were. 

More Americans are unable to pay their credit card bills in full at the end of the month, with 46% of credit cardholders carrying month-to-month debt, up from 39% in 2022. A recent report from the Federal Reserve Bank of New York highlighted how the current 15% year-to-year credit card balance increase represents the largest jump in more than 20 years.

It’s undeniable that ordinary people are facing higher prices across the board, and are increasingly unable to make credit card payments. That’s because payments giants like PayPal are taking advantage of consumers, and we’ve all been letting them get away with it.

As credit card spending in the United States almost entirely benefits Visa and Mastercard, who handle 80% of total transactions, the failure of the competitive model in the credit card industry may be to blame for at least part of the crisis at hand

Related: Did regulators intentionally cause a run on banks?

But that’s not all: With the highest credit card swipe fees of any major economy, American businesses pay up to seven times more in swipe fees than businesses in Europe, and five times more than businesses in China — a cost that gets passed down directly to consumers. In order to avoid shouldering transaction costs, merchants are forced to set higher prices than they would prefer — that’s prices for all consumers, not just those choosing to pay by credit card — which essentially means that anyone paying by cash or debit card is forced to pay a higher price for the convenience of a select few.

It’s true that electronic payments are convenient, and they’ve solved many of the cross-border problems posed by an old cash-only mentality. However, consumers end up paying a lot more for this comfort than they might have been led to believe, and they might not even know it.

In 2023, the technology at our disposal is so advanced that centralized services imposing limits on merchants’ or customers’ rights to send and spend simply should not exist.

Why, in today’s world, should anyone be forced to use a centralized service that is specifically designed to take such a big cut of their every purchase?

By replacing old systems and traditional payment providers — which serve the greater monopoly rather than hard-working ordinary people — distributed solutions can save consumers and merchants more money. In order to do this in a safe and transparent fashion, however, volatility cannot be a part of the equation, which means traditional cryptocurrencies cannot be the answer. But stablecoins could be.

Stablecoins are specifically designed for price continuity, as the name suggests. Their value is directly tied, or pegged, to a “stable” reserve asset, like a precious metal or the U.S. dollar, so their price is ultimately fixed. By allowing for real-time payments over blockchain networks, they offer faster and more efficient money movement than their fiat counterparts. With a more concrete value proposition for everyday use, they represent a more effective alternative to more highly volatile cryptocurrencies.

But with some stablecoins going as far as offering 99% cheaper fees for consumers and merchants compared to what the current global payment solution providers offer, they also represent a good way out of our dependency on credit cards as a whole.

In a 2021 speech, the Federal Reserve Board’s vice chairman for supervision, Randal Quarles, invited us to “not fear stablecoins,” as their potential benefits should be taken into “strong account,” and “the possibility that a U.S. dollar stablecoin might support the role of the dollar in the global economy.” Elsewhere in the world, things are moving in a similar direction. For example, the Digital Euro Association sees “automated micropayments as a way for Europe to maintain its digital competitiveness.”

The solution may be found in stablecoins themselves or in the mix between traditional financial structures and the innovations of Web3, and it could be easier to implement than we might think.

Related: Bank collapses are spurring interest in self-custody startups

Since merchants may be reluctant to build up the necessary crypto knowledge they would need to accept stablecoins, they could instead look to providers who would allow them to both accept stablecoins as a currency, and get settled into bankable fiat currency without the need to change accounting procedures. The stablecoin provider could add value, security and transparency to its proposition by getting the stamp of approval of something like a bank guarantee, in which case the value of the stablecoin in question would be fully protected, and consumers’ peace of mind would be assured.

The important thing to remember is that both merchants and consumers — sick of a system keeping them hostage — are desperate for innovative solutions to a crisis that’s been left unchecked for simply too long. To this end, the mainstream use of stablecoins as a means of payment does have the potential to save us from our dependency on the credit card industry and even drive down gouged consumer prices. Their value proposition shouldn’t be overlooked.

What will it take to implement a cheaper, more efficient and straightforward way to conduct business? Are we resigned to letting ourselves be taken advantage of? If the answer is no, then stablecoins and other low-fee Web3 solutions may be where we need to start.

Bernhard Müller is the founder, chairman and general manager at Centi. After a 10-year career in healthcare engineering, he worked for a global blockchain company in business development and compliance. He holds an M.Sc. in biology and started following Bitcoin in 2011.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph

OKX to cease operations in Canada by June 22 2023

“Withdrawals from OKX will continue to be available,” wrote the OKX team in an email to users. ͏ ͏ ͏ ͏

On Mar. 20, cryptocurrency exchange OKX informed Canadian users via email the firm “will no longer provide services or allow users to open new accounts in Canada starting on Mar. 24, 2023, 12:00 AM EST,” citing “new regulations.” According to OKX, existing Canadian customers must close open positions in options, margins, perpetual, and futures by June 22, 2023. Fiat or tokens must also be withdrawn by the said date.

“Your funds will remain safe in your account until you withdraw them. You will be able to withdraw dollars to your linked bank account and cryptocurrency to your self-custody wallet or your cryptocurrency account on another exchange. “

OKX says its withdrawal from Canada is “temporary,” and the exchange is working with regulators to solve this issue. “We hope to see you again in the future. Stay tuned,” wrote OKX staff. Previously, cryptocurrency exchange Bittrex Global off-boarded Canadian users on July 29, 2022, after giving advance notice, which, too, cited regulatory developments as reasons for leaving the country.

On Feb. 22, the Canadian Securities Administrators (CSA) published a notice requiring crypto exchanges to sign new, legally-binding undertakings while they await registration with the regulatory. Among many items, the new undertaking prohibits “buying or depositing Value Referenced Crypto Assets (commonly referred to as stablecoins) through crypto contracts without the prior written consent of the CSA.” Although it appears stablecoin USD Coin (USDC) has not been affected by the ruling. 

Currently, all cryptocurrency exchanges must register with Canadian regulators before onboarding users in the country. On June 22, 2022, cryptocurrency exchanges ByBit and KuCoin were issued millions of dollars in fines after the Ontario Securities Comission determined that determined both were operating as “non-compliant platforms” in the country.

The off-boarding message sent to Canadian OKX users on Mar. 20 2023 | Source: OKX

OKX to cease operations in Canada by June 22, 2023

“Withdrawals from OKX will continue to be available,” the OKX team wrote in an email to users. ͏ ͏ ͏ ͏

On March 20, cryptocurrency exchange OKX informed Canadian users via email the firm “will no longer provide services or allow users to open new accounts in Canada starting on Mar. 24, 2023, 12:00 AM EST,” citing “new regulations.” According to OKX, existing Canadian customers must close open options, margins, perpetual and futures positions by June 22. Fiat or tokens must also be withdrawn by that date.

“Your funds will remain safe in your account until you withdraw them. You will be able to withdraw dollars to your linked bank account and cryptocurrency to your self-custody wallet or your cryptocurrency account on another exchange. “

OKX said its withdrawal from Canada is “temporary” and that it’s working with regulators to solve the issue. “We hope to see you again in the future. Stay tuned,” wrote OKX staff. Previously, cryptocurrency exchange Bittrex Global off-boarded Canadian users on July 29, 2022 after giving advance notice, also citing regulatory developments as reasons for leaving the country.

On Feb. 22, the Canadian Securities Administrators (CSA) published a notice requiring crypto exchanges to sign new, legally binding undertakings while they await registration with the regulatory. Among many items, the new undertaking prohibits “buying or depositing Value Referenced Crypto Assets (commonly referred to as stablecoins) through crypto contracts without the prior written consent of the CSA,” although it appears the stablecoin USD Coin (USDC) has not been affected by the ruling.

Currently, all cryptocurrency exchanges must register with Canadian regulators before onboarding users in the country. On June 22, 2022, cryptocurrency exchanges ByBit and KuCoin were issued millions of dollars in fines after the Ontario Securities Commission determined that determined both were operating as “non-compliant platforms” in the country.

The off-boarding message sent to Canadian OKX users on March 20, 2023. Source: OKX

Federal Reserve confirms July launch for FedNow instant payment service

The FedNow service aims to reduce the gap in payment time between United States financial institutions.

The United States Federal Reserve has confirmed a July launch date for its long-awaited instant payments system, seen by some as an alternative to central bank digital currencies and stablecoins.

The instant payment network will settle payments in seconds and can support transactions between consumers, merchants and banks. It does not rely on blockchain technology.

It’s a significant step for the government, as it is controlled by the Federal Reserve. Clearing House’s RTP network, which also offers real-time payments, is operated by a consortium of large banks. 

According to a March 15 announcement, the U.S. Fed said the debut of FedNow is set for July, with the U.S. Treasury and a “diverse mix of financial institutions of all sizes” ready to use the network from launch.

The Fed said it will “begin the formal certification of participants” during the first week of April in preparation for the launch.

“Early adopters will complete a customer testing and certification program, informed by feedback from the FedNow Pilot Program, to prepare for sending live transactions through the system,” the announcement reads.

FedNow was announced in 2019 and will provide round-the-clock, real-time gross settlement by funneling commercial bank money from a sender through a Fed credit account to its recipient. It also has built in features such as fraud risk management.

Following the official launch, the Federal Reserve outlined that it will push to onboard as many as financial institutions as possible in order to increase the availability of instant payments.

“The launch reflects an important milestone in the journey to help financial institutions serve customer needs for instant payments to better support nearly every aspect of our economy,” Tom Barkin, president of the Federal Reserve Bank of Richmond and FedNow Program executive sponsor, said in the announcement.

Some see the FedNow service as tackling a problem that both stablecoins and CBDCs also seek to solve.

The FedNow program, however, doesn’t use blockchain tech, while the Federal Reserve is known to have a cautious and skeptical view on stablecoins. 

Tweet from Meltem Demirors on FedNow. Source: Twitter

One of the major banking payment rails servicing U.S. crypto companies in the Silvergate Exchange Network (SEN) was shut down earlier this month following Silvergate’s collapse.

As it stands, SEN competitor SigNet from Signature Bank is still operational despite the bank’s forced closure on March 13. However, its fate is up in the air, while a number of companies have reportedly fled from the network following Signature’s troubles.

FedNow could also stand in place of a central-bank-issued digital currency.

Federal Reserve Vice Chair Lael Brainard emphasized during a House of Representatives Committee on Financial Services hearing in May that a CBDC would take far longer to get off the ground than FedNow due to regulatory hurdles.

“[If] Congress were to decide… to issue a central bank digital currency, it could take five years to put in place the requisite security features, the design features,” she said.

She added that FedNow will serve many of the same functions as a CBDC anyhow.

Related: Tassat blockchain to join FedNow service with B2B on-ramp as pilot prepares for launch

Fed chair Jerome Powell also spoke before the House Financial Services Committee on March 9 and suggested that a potential U.S. CBDC is still quite some time away.

“We’re not at the stage of making any real decisions,” he said, adding that “what we’re doing is experimenting in kind of early stage experimentation. How would this work? Does it work? What’s the best technology? What’s the most efficient?”

Commenting on FedNow, however, he stated that “we’ll have real-time payments in this country very, very soon.”

Debtors saved over $100M using de-pegged stablecoins to repay loans

Debtors jumped on the opportunity to grab a discount on their loan repayments when USDC and DAI de-pegged from the dollar.

The depegging of USD Coin (USDC) and Dai (DAI) from the United States dollar prompted a frenzy of loan repayments over the weekend, allowing debtors to save a total of more than $100 million on their loans.

Following the collapse of Silicon Valley Bank on March 10, the USDC price dropped to lows of $0.87 on March 11 amid concerns about its reserves being locked at SVB.

MakerDAO’s stablecoin DAI also de-pegged briefly, going as low as $0.88 on March 11, according to CoinGecko.

The USDC price briefly dropped to lows of $0.87 on March. 11. Source: Cointelegraph

The depegging, in the backdrop of broader crypto turmoil, led to more than $2 billion in loan repayments on March 11 on decentralized lending protocols Aave and Compound — with more than half made in USDC, according to a report by digital assets data provider Kaiko. 

Another $500 million in debts were paid in DAI on the same day, it noted.

Digital assets data provider Kaiko found over $1 billion in USDC loan repayments on March. 11. Source: Kaiko

This tapered off as both USDC and DAI started heading back toward their peg. The following days did not have anywhere near as many repayments, with a rough total of only $500 million in loan repayments across Tether (USDT), USDC, DAI and other coins on March 12, and roughly half of that on March 13.

Blockchain analytics firm Flipside Crypto estimates that USDC debtors saved $84 million as a result of paying back loans while the stablecoin was de-pegged, while those using DAI saved $20.8 million.

Debtors used de-pegged stablecoins to save millions in loan repayments. Source: Flipside Crypto

“Overall, DeFi markets experienced two days of huge price dislocations that generated countless arbitrage opportunities across the ecosystem, and highlighted the importance of USDC,” the Kaiko report said. 

Related: USDC depegged, but it’s not going to default

The depegging of USDC also led MakerDAO to reconsider its exposure to USDC, as crypto projects incorporating DAI in their tokenomics suffered losses due to a chain reaction.

Circle’s USDC began its climb back to $1 following confirmation from CEO Jeremy Allaire that its reserves were safe and the firm had new banking partners lined up, along with government assurances that depositors of SVB would be made whole.

According to CoinGecko data, USDC was sitting at $0.99 at the time of writing.

How and why do stablecoins depeg?

Discover the causes and mechanisms behind stablecoin depegs.

Stablecoins are a type of cryptocurrency designed to have a stable value relative to a specific asset or a basket of assets, typically a fiat currency such as the U.S. dollar, euro or Japanese yen.

Stablecoins are designed to offer a “stable” store of value and medium of exchange compared with more traditional cryptocurrencies like Bitcoin (BTC) and Ether (ETH), which can be highly volatile.

Fiat money, cryptocurrencies, and commodities like gold and silver are examples of assets used to collateralize or “back” stablecoins. Tether (USDT), USD Coin (USDC) and Dai (DAI) are a few examples of stablecoins pegged to the U.S. dollar.

Stablecoins can also be algorithmically stabilized through smart contracts and other mechanisms that automatically adjust the supply of the stablecoin to maintain its peg to the underlying asset.

Despite the potential benefits, stablecoins are not without risks. The most significant risk with any stablecoin is the potential for its peg to break, causing it to lose its value relative to the underlying asset.

Depegging is where the value of a stablecoin deviates significantly from its pegged value. This can happen for various reasons, including market conditions, liquidity issues and regulatory changes.

USDC is a fully reserved-backed stablecoin, meaning every USD Coin is backed by actual cash and short-dated United States treasuries. Despite this, USDC issuers, Circle, announced on March 10 that USDC had depegged from the U.S. dollar, with around $3.3 billion of its $40 billion in USDC reserves stuck in the now defunct Silicon Valley Bank. The bank — the 16th-largest in the U.S. — collapsed on March 10, and is one of the biggest bank failures in U.S. history. Given USDC’s collateral influence, other stablecoins followed suit in depegging from the U.S. dollar.

Related: USDC depegs as Circle confirms $3.3B stuck with Silicon Valley Bank

MakerDAO — a protocol based on the Ethereum blockchain — issues DAI, an algorithmic stablecoin designed to preserve a precise 1:1 ratio with the U.S. dollar. However, DAI also fell off its peg amid the Silicon Valley Bank’s collapse, mainly due to a contagion effect from USDC’s depegging. Over 50% of the reserves backing DAI are held in USDC.

Tether issues USDT, with every USDT token equivalent to a corresponding fiat currency at a 1:1 ratio and fully backed by Tether’s reserves. However, USDT also experienced a depegging in 2018, which raises concerns about the overall stability mechanism of stablecoins.

Importance of stablecoin pegs

The importance of stablecoin pegs is in providing a stable and predictable value relative to an underlying asset or basket of assets — typically a fiat currency like the U.S. dollar. Stablecoins are a desirable alternative for various use cases, including cryptocurrency trading, payments and remittances, due to their stability and predictability.

With stablecoin pegs, traders may enter and exit positions without being subjected to the price fluctuations of cryptocurrencies like BTC or ETH. This is important for institutional investors and companies that depend on a reliable store of value and a medium of exchange to run their operations.

Cross-border transactions can also be made more accessible using stablecoin pegs, especially in nations with volatile currencies or restricted access to conventional financial services. Compared with more traditional methods like wire transfers or remittance services, stablecoins can offer a more effective and affordable way to make payments and transfer value across borders.

Stablecoin pegs can also increase financial inclusion, especially for people and enterprises without access to traditional financial services. Stablecoins can be used to make payments and transact in digital assets without requiring a bank account or credit card, which can be crucial in developing and emerging markets.

Why do stablecoins depeg?

Stablecoins can depeg due to a combination of micro and macroeconomic factors. Micro factors include shifts in market conditions, such as an abrupt increase or decrease in stablecoin demand, problems with liquidity and modifications to the underlying collateral. Macro variables involve changes in the overall economic landscape, such as inflation or interest rate increases.

For instance, a stablecoin’s price can momentarily exceed its pegged value if demand spikes due to increased cryptocurrency trading activity. Yet, the stablecoin’s price could drop below its fixed value if insufficient liquidity matches heightened demand.

On the macroeconomic front, if there is high inflation, the purchasing power of the underlying assets that support the stablecoin may drop, leading to a depeg event. Similarly, adjustments to interest rates or other macroeconomic measures may impact stablecoin demand.

Regulatory changes or legal issues can also cause a stablecoin to depeg. For example, if a government were to ban the use of stablecoins, demand for the stablecoin would drop, causing its value to fall. A depegging event can also be caused by technical problems like smart contract bugs, hacking attacks and network congestion. For instance, a smart contract flaw could result in the stablecoin’s value being computed improperly, causing a sizable departure from its peg.

How do stablecoins depeg?

Stablecoin depegging typically occurs in a few steps, which may vary depending on the specific stablecoin and the circumstances that lead to the depegging event. The following are some general features of a depegging event:

The stablecoin’s value deviates from its peg

As noted, many factors, such as market turbulence, technological problems, a lack of liquidity and regulatory problems, may result in a stablecoin depeg. The value of the stablecoin may change dramatically relative to the pegged asset or basket of assets.

Traders and investors react to the depegging event

Whether they think the stablecoin’s value will eventually return to its peg or continue to diverge from it, traders and investors may respond by purchasing or selling the stablecoin when it dramatically departs from its peg.

Arbitrage opportunities arise

Arbitrage opportunities could materialize if the stablecoin’s value drifts away from its peg. For instance, traders may sell the stablecoin and purchase the underlying asset to benefit if the stablecoin’s value is higher than its peg.

The stablecoin issuer takes action

The stablecoin issuer may take action to rectify the problem if the stablecoin’s value continues to stray from its peg. This may entail changing the stablecoin’s supply, the collateralization ratio and other actions to boost trust in the stablecoin.

The stablecoin’s value stabilizes

If traders and investors adjust their positions and the stablecoin issuer responds to the depegging event, the value of the stablecoin may stabilize. The stablecoin’s value might return to its peg if the stablecoin issuer successfully wins back public trust.

Risks and challenges associated with stablecoins depegging

Depegging stablecoins can present several risks and difficulties for investors, traders and the larger cryptocurrency ecosystem:

  • Market volatility: When stablecoins depeg, the market may experience severe turbulence as traders and investors alter holdings in response to the depegging event. This could lead to market uncertainty and raise the possibility of losses.
  • Reputation risk: Depegging stablecoins risks the issuers’ and the larger cryptocurrency ecosystem’s reputation. This may make it harder for stablecoin issuers to draw in new users and investors and decrease the market’s total value.
  • Liquidity risk: Liquidity issues may arise if a stablecoin depegs because traders and investors sell the stablecoin in significant quantities. As a result, the value of the stablecoin may decrease, making it challenging for traders and investors to liquidate their holdings.
  • Counterparty risk: Traders and investors may be exposed to the risk of default by the stablecoin issuer or other parties participating in the stablecoin’s operation due to the depeg event.
  • Regulatory risk: Stablecoins depegging can also bring about regulatory problems. Governments and authorities may impose restrictions on stablecoins if they believe that the assets threaten the stability of the broader financial system.

Related: Circle’s USDC instability causes domino effect on DAI, USDD stablecoins

Considering the above risks, investors and traders alike should keep a close eye on the performance of stablecoins in their portfolios. Research the stablecoin issuer and its collateralization, and be on the lookout for any indications of depegging or other problems that might impact the stablecoin’s value. They can also think about diversifying their holdings by using a variety of stablecoins or other assets. This can lessen the chance of suffering losses in a stablecoin depegging event.

​​Stablecoins and Ether are ‘going to be commodities,’ reaffirms CFTC chair

In the tug-of-war between the United States regulators over control of crypto assets, the Commodity Futures Trading Commission chair has tripled-down on his stance that Ether and stablecoins are commodities.

Stablecoins and Ether (ETH) are commodities that should come under the purview of the United States Commodity Futures Trading Commission, its chairman has again asserted at a recent Senate hearing.

At the March 8 Senate Agricultural hearing, CFTC chair Rostin Behnam was asked by Senator Kirsten Gillibrand about the differing views held by the regulator and the Securities and Exchange Commission following the CFTC’s 2021 settlement with stablecoin issuer Tether. Behnam replied:

“Notwithstanding a regulatory framework around stablecoins, they’re going to be commodities in my view.”

“It was clear to our enforcement team and the commission that Tether, a stablecoin, was a commodity,” he added.

In the past, the CFTC has asserted that certain digital assets such as Ether, Bitcoin (BTC) and Tether (USDT) were commodities — such as in its lawsuit against FTX founder Sam Bankman-Fried in mid-December.

Asked what evidence the CFTC would put forward to win regulatory influence over Ether during the Senate hearing, Behnam said it “would not have allowed” Ether futures products to be listed on CFTC exchanges if it “did not feel strongly that it was a commodity asset,” adding:

“We have litigation risk, we have agency credibility risk if we do something like that without serious legal defenses to support our argument that [the] asset is a commodity.”

The comment has seemingly cemented Behnam’s sometimes wavering opinion on the classification of Ether. During an invite-only event at Princeton University in November last year he said Bitcoin was the only cryptocurrency that could be viewed as a commodity, leaving out Ether. Only a month before that, he suggested Ether could be viewed as a commodity too.

Related: CFTC continues to explore digital asset policy considerations in MRAC meeting

Behnam’s most recent comments oppose a view held by SEC chair, Gary Gensler, who claimed in a Feb. 23 New York Magazine interview that “everything other than Bitcoin” is a security, a claim that was rebuffed by multiple crypto lawyers.

The differing viewpoints of the market regulators could set the stage for a conflict as each vies for regulatory control of the crypto industry.

In mid-Febuary, the SEC flexed its authority against stablecoin issuer Paxos saying it may sue the firm for violating investor protection laws alleging its Binance USD (BUSD) stablecoin is an unregistered security.

Around the same time, the regulator similarly targeted Terraform Labs and called its algorithmic stablecoin TerraUSD Classic (USTC) a security, a move Delphi Labs general counsel, Gabriel Shapiro, said could be a “roadmap” for how the SEC could structure future suits against other stablecoin issuers.

The SEC’s crypto clampdowns have seen pushback from the industry. Circle founder and CEO Jeremy Allaire said he doesn’t believe “the SEC is the regulator for stablecoins,” saying they should be overseen by a banking regulator.

Bitcoin leverage ramps up as BTC’s margin long-to-shorts ratio hits a record $2.5B high

BTC traders at Bitfinex and OKX are unwilling to use margin markets for bearish bets, creating an alarming imbalance that investors should pay close attention to.

Crypto traders’ urge to create leverage positions with Bitcoin (BTC) appears irresistible to many people, but it’s impossible to know if these traders are extreme risk-takers or savvy market-makers hedging their positions. The need to maintain hedges holds even if traders rely on leverage merely to reduce their counterparty exposure by maintaining a collateral deposit and the bulk of their position on cold wallets.

Not all leverage is reckless

Regardless of the reason for traders’ use of leverage, currently there is a highly unusual imbalance in margin lending markets that favors BTC longs betting on a price increase. Despite this, so far, the movement has been restricted on margin markets because the BTC futures markets remained relatively calm throughout 2023.

Margin markets operate differently from futures contracts in two main areas. Those are not derivatives contracts, meaning the trade happens on the same order book as regular spot trading and, unlike futures contracts, the balance between margin longs and shorts is not always matched.

For instance, after buying 20 Bitcoin using margin, one can literally withdraw the coins from the exchange. Of course, there must be some form of collateral, or a margin deposit, for the trade, and this is usually based on stablecoins. If the borrower fails to return the position, the exchange will automatically liquidate the margin to repay the lender.

The borrower must also pay an interest rate for the BTC bought with margin. The operational procedures will vary between marketplaces held by centralized and decentralized exchanges, but usually the lender gets to decide the rate and duration of the offers.

Margin traders can either long or short

Margin trading allows investors to leverage their positions by borrowing stablecoins and using the proceeds to buy more cryptocurrency. When these traders borrow Bitcoin, they use the coins as collateral for short positions, which means they are betting on a price decrease.

That is why analysts monitor the total lending amounts of Bitcoin and stablecoins to understand whether investors are leaning bullish or bearish. Interestingly, Bitfinex margin traders entered their highest leverage long/short ratio on Feb. 26.

Bitfinex margin Bitcoin longs/shorts ratio. Source: TradingView

Historically, Bitfinex margin traders are known for creating margin positions of 10,000 BTC or higher quickly, indicating the participation of whales and large arbitrage desks.

As the above chart indicates, on Feb. 26, the BTC/USD long (bulls) margin demand outpaced shorts (bears) by 133 times, at 105,300 BTC. Before 2023, the last time this indicator reached an all-time high favoring longs was Sept. 12, 2022. Unfortunately, for bulls, the result benefited bears as Bitcoin nosedived 19% over the following six days.

Traders should cross-reference the data with other exchanges to ensure the anomaly is market-wide, especially since each marketplace holds different risks, norms, liquidity and availability.

OKX, for instance, provides a margin lending indicator based on the stablecoin/BTC ratio. At OKX, traders can increase exposure by borrowing stablecoins to buy Bitcoin. On the other hand, Bitcoin borrowers can only bet on the decline of a cryptocurrency’s price.

OKX stablecoin/BTC margin lending ratio. Source: OKX

The above chart shows that OKX traders’ margin lending ratio increased through February, signaling that professional traders added leveraged long positions even as Bitcoin price failed to break the $25,000 resistance multiple times between Feb. 16 and Feb. 23.

Furthermore, the margin ratio at OKX on Feb. 22 was the highest level seen in over six months. This level is highly unusual and matches the trend seen at Bitfinex where a strong imbalance favored Bitcoin margin longs.

Related: Can Bitcoin reach $25K again in March 2023? Watch Market Talks live

The difference in the cost of leverage could explain the imbalance

The rate for leverage BTC longs at Bitfinex has been almost nonexistent throughout 2023, currently sitting below 0.1% per year. In short, traders should not panic, considering the cost of margin lending remains in a zone that is deemed healthy, and the imbalance is not present in futures contracts markets.

There may be a plausible explanation for the movement, which did not happen overnight. For instance, a possible culprit is the rising cost of stablecoin lending.

Instead of the minimal rate offered for Bitcoin loans, stablecoin borrowers pay 25% per year on Bitfinex. That cost increased significantly in November 2022 when the leading derivatives exchange FTX and their market-maker, Alameda Research, blew up.

As long as Bitcoin margin markets remain extremely unbalanced, traders should continue monitoring the data for additional signs of stress. Currently, no red flags are raised, but the size of the Bitfinex BTC/USD longs ($2.5 billion position) should be a reason for concern.

The views, thoughts and opinions expressed here are the authors’ alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.