Stablecoin Watch: The Great Stagnation
- By Dalvir Mandara
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- 8 min read
Summary
- USDN breaks its peg for over a month.
- The overall stablecoin market cap flattens.
- BUSD and USDP register the largest gains in market cap over the past month.
- Rate hikes from the Fed push 3M treasury yields above stablecoin yields on Compound.
Stablecoin Market Cap Flattens
Over four months have passed since the Terra fiasco saw one of the biggest (algorithmic) stablecoins, TerraUSD (UST), break its peg and collapse in a matter of days. This was the catalyst to the subsequent crypto credit crunch, during which some of the biggest players in the space (e.g., Celsius) collapsed. Stablecoin efficacy has been the subject of much debate since. True, the sector has taken a beating over the past four months, with many other algorithmic stablecoins struggling to maintain their dollar pegs. But if we zoom out, where are we now in relation to the past 18 months or so?
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Summary
- USDN breaks its peg for over a month.
- The overall stablecoin market cap flattens.
- BUSD and USDP register the largest gains in market cap over the past month.
- Rate hikes from the Fed push 3M treasury yields above stablecoin yields on Compound.
Stablecoin Market Cap Flattens
Over four months have passed since the Terra fiasco saw one of the biggest (algorithmic) stablecoins, TerraUSD (UST), break its peg and collapse in a matter of days. This was the catalyst to the subsequent crypto credit crunch, during which some of the biggest players in the space (e.g., Celsius) collapsed. Stablecoin efficacy has been the subject of much debate since. True, the sector has taken a beating over the past four months, with many other algorithmic stablecoins struggling to maintain their dollar pegs. But if we zoom out, where are we now in relation to the past 18 months or so?
The stablecoin market cap (considering the top 10 coins) trended up throughout the crypto bull run of 2021 and even into the first few months of 2022 (according to data from CoinGecko). It peaked at around $170bn in March 2022 (Chart 1). It is currently around $150bn, having lost $20bn since the March highs. Since July, it has been flattening at around the $150bn mark. USDT and USDC continue to dominate the lion’s share of this market cap at around 46% and 34% each.
We can view the stablecoin supply as a proxy for measuring liquidity and demand for leverage. This is because a vast amount of crypto trading occurs between crypto-stablecoin pairs on some of the biggest (crypto) exchanges in the world (e.g., Binance). According to a report by Morgan Stanley, a contraction of the stablecoin market cap is akin to quantitative tightening of the crypto financial system – much like how central banks reduce their balance sheet to remove liquidity from financial markets. So, a flattening of the aggregate market cap may point to a flattening of liquidity/demand for leverage.
Unstable Coins
Algorithmic stable coins are still not that stable. The latest coins to have broken their peg to the dollar are Wave protocol’s USDN and Fei protocol’s FEI (Charts 2 and 3). Both are algorithmic stablecoins and have had trouble holding onto their dollar pegs several times over the past month.
USDN has not recovered its peg for over a month now, and the DAO that runs the FEI stablecoin (TribeDAO) proposed dissolution. The announcement cited the ‘challenging macro environment’ as one of the reasons for placing the DAO in a ‘suboptimal state.’
Regulatory Pressures
Since the TerraUSD collapse, regulatory and legal pressure on the stablecoin market has increased (particularly on algorithmic stablecoins). Some of the latest events include:
- In response to a lawsuit that claims Tether (USDT) used USDT to inflate the crypto market, a US Judge ordered Tether (USDT) to produce documents including balance sheets and cashflow statements that relate to the backing of USDT.
- The latest draft of a US stablecoin bill would see new algorithmic stablecoins (like TerraUSD) banned for two years.
- The UK introduced a bill to regulate stablecoins as a form of payment.
Regulation is not necessarily a bad thing, though. On the one hand, overregulation could stifle innovation. But it could also restore confidence in the crypto sector after the damage done by the TerraUSD collapse, the subsequent crypto credit crunch, and the numerous hacks this year (Wintermute, one of the largest crypto market makers being the latest victim).
Proper regulation of stablecoin markets could usher in a new wave of investment if people feel safer about the increased transparency that should accompany it.
Latest Developments
Market Cap and Peg Risk
Pax Dollar (USDP, +15%) and Binance USD (BUSD, +12%) are up the most in terms of their market cap over the past 30 days (Chart 4). The significant increase in BUSD market cap comes after Binance announced that, from 29 September, it will automatically convert all USDC, USDP, and TUSD holdings on the platform into BUSD. They also recently announced that BUSD is expanding onto the Polygon and Avalanche chains.
All other stablecoins (except USDT) registered a drop in market cap, with Magic Internet Money (MIM) leading loses at 7%.
Volatility
The one-month annualised volatility of USDN is the highest at a staggering 27% (Chart 5). This is due to the peg break from which it has yet to recover.
Over the past three months and year, FRAX and MIM join USDN as the top three most volatile stablecoins. Notably, FRAX is another algorithmic stablecoin. The least volatile stablecoins remain the fiat-collateralised ones.
Yields
Turning to yields, on Compound, average lending and borrowing rates are up for all five stablecoins we track (Charts 6 and 7). Continual rate hikes from the Fed to combat stubborn inflation have now pushed US 3M treasury yields higher than the yields on all five stablecoins we track on Compound.
Appendix
USDT: Tether is a fiat-collateralised stablecoin primarily issued on the ethereum and bitcoin blockchains. It aims to be pegged 1:1 against the US dollar. Tether’s reserves are not backed 100% by US dollar deposits. Instead, they are backed by reserves that include cash, cash equivalents, short-term deposits, commercial paper, corporate bonds, funds, precious metals, secured loans, and other investments including digital tokens.
USDC: USD Coin is a fiat-collateralised stablecoin issued as ERC-20 tokens on the ethereum blockchain. It is 100% backed by cash and short-dated US treasuries. USDC publishes a monthly public attestation of 100% reserves.
BUSD: Binance USD is a fiat-collateralised stablecoin issued as ERC-20 tokens on the ethereum blockchain. It is backed 100% by USD held in Paxos-owned US bank accounts and US treasury bills (including through repurchase agreements and/or money-market funds invested in US treasury bills). Paxos is a New-York-regulated financial institution and publishes a monthly public attestation of 100% reserves.
TUSD: TrueUSD is a fiat-collateralised stablecoin issued by the TrustToken platform that is issued as ERC-20 tokens on the ethereum blockchain. It aims to maintain its 1:1 peg against the US dollar by being fully collateralised by US dollars using multiple escrow accounts to reduce counterparty risk.
USDP: Pax Dollar is a fiat-collateralised stablecoin issued as ERC-20 tokens on the ethereum blockchain. It aims to be pegged 1:1 against the US dollar by holding USD reserves in Paxos owned US bank accounts.
DAI: Dai is a crypto-collateralised stablecoin that attempts to maintain a 1:1 peg against the US dollar by depositing other crypto assets into smart contracts on the ethereum blockchain every time a new DAI token is issued. DAI is maintained by a decentralised autonomous organisation (DAO) called MakerDAO. And since the mechanism is maintained by a system of smart contracts, it has higher decentralisation than the centralised entities controlling USDT, USDC, or BUSD.
MIM: Magic Internet Money is a crypto-collateralised stablecoin launched by the DeFi platform Abracadabra. MIM is backed by interest-bearing tokens (ibTKN).
UST: TerraUSD is a crypto-collateralised hybrid stablecoin native to the Terra blockchain. To mint 1 UST, $1 worth of UST’s reserve asset, LUNA, must be burned. The idea was to try and ensure LUNA’s long-term growth. More people buying into UST means more LUNA gets burned, which should make the remaining LUNA supply more valuable. However, the system collapsed recently when UST de-pegged from the US dollar.
FRAX: Frax Finance is a fractional-algorithmic stablecoin that uses both collateralisation and an algorithmic process to create its decentralised stablecoin that is pegged 1:1 to the US dollar. Only stablecoins (currently, USDC) are accepted as collateral by the protocol.
FEI: FEI is an algorithmic stablecoin that aims to be pegged 1:1 against the U.S dollar that is backed mostly by ETH.
Dalvir Mandara is a Quantitative Researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham. His areas of interest are in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.