Stablecoins are becoming unstable; will $USDC end up like Terra’s $UST?

The crypto community was in temporal jeopardy over the weekend when, due to reports that several crypto-friendly banks in the United States packed up, one of the most prominent stablecoins in the market, $USDC lost its peg to the US dollar and dropped as low as $0.8. 

Although the Circle-issued stablecoin regained its peg on Monday, the discussion on how stablecoin de-pegging has become a recurrent theme in the crypto space still lingers. 

For the uninitiated, 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 US dollar, Nigerian naira, euro or Japanese yen. 

They are designed to offer a “stable” store of value and medium of exchange compared with more traditional cryptocurrencies like Bitcoin, which can be highly volatile. Fiat money, cryptocurrencies, and commodities like gold and silver are examples of assets used to collateralise or “back” stablecoins. The leading stablecoins in the space include the Tether-issued $USDT, Circle-issued $USDC, Binance’s $BUSD, $DAI and the defunct Terra’s $UST. 

The problem now is the only stablecoin that hasn’t encountered problems or depegged in the last ten months is Tether $USDT. All others have, at one point, put traders in a state of panic by losing their peg to $1. As a matter of fact, Terra’s $UST, which is supposed to be a stablecoin, currently trades at $0.02, a 97% decrease from the $1 mark.

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In this analysis, we will examine why stablecoins depeg and if there are possibilities that $USDC will end up like $UST.

Why do stablecoins depeg?

The most significant risk with any stablecoin is the potential for its peg to break. Depegging is where the value of a stablecoin deviates significantly from its pegged value. 

Stablecoins can depeg due to a combination of micro and macroeconomic factors. These include shifts in market conditions, such as an abrupt increase or decrease in stablecoin demand, problems with liquidity and modifications to the underlying collateral. 

In simpler terms, 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. This was the dynamics that affected Terra’s $UST last year. 

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. This factor caused the recent depeg of $BUSD and $USDC. 

Will $USDC go the $UST way?

Although $USDC has since regained its peg to the US dollar, there are justifiable fears that it might end up like $UST especially since the full effect of its exposure to SVB has not been revealed. However, amidst this fear, $USDC would not likely crash to zero like $UST, the algorithmic stablecoin by Terra, did. 

Recall that the collapse of $UST was attributed to its structure and backing by other digital assets, including Bitcoin and $LUNA. Since it depended on algorithms to track the value of the USD and always ensure parity, any pressure on its underlying coins(Bitcoin or LUNA), led to intense selling pressure, which caused a de-peg.

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Now, USDC, issued by Circle, is backed 1:1 with cash, and redemption means every backing cash or cash equivalent from Circle must be sold and disbursed to the client. Reports showed that out of the entire basket of assets backing $USDC circulating supply, only $3.3 billion are stuck in SVB, less than 9% of its market cap’s USD equivalent. And even the funds are expected to be recovered sooner or later through bank insurance procedures.

As a result, the damage done by its exposure to SVB might have been exaggerated. That’s why it is overdramatic to compare the $USDC troubles to those that led to the collapse of the Terra ecosystem almost a year ago. 

Conclusion 

The tremors caused by Circle’s exposure to SVB have reverberated through the crypto sphere, and as the dust continues to settle, questions are still hanging, not only on $USDC but overall stablecoins and their ability to maintain their pegs in times of distress. 

Panic over SVB is over. Now, the onus lies on the crypto industry to regain public trust regarding stablecoins which is one of the bedrock of mainstream adoption, by putting in place measures to prevent future systemic failures.