Stablecoins are cryptocurrencies whose values are tied to a fiat currency, most commonly the USD. Essentially, stablecoins assure that one unit of the cryptocurrency will maintain a value equivalent to 1 USD. Depending on the mechanisms by which the stability of its value is upheld, they can be broadly categorised into the following types:

• Fiat-Collateralized Stablecoins: These stablecoins are backed by a reserve of fiat currency at a 1:1 ratio, meaning for each stablecoin issued, a certain amount of fiat currency is held in reserve. Examples include Tether (USDT) — one of the largest fiat-collateral stablecoin which uses US dollars as its reserves; as well as USDC
• Crypto-Collateralized Stablecoins: Stablecoins that hold reserves in the form of other cryptocurrencies. Given that cryptocurrencies are inherently volatile, these stablecoins need to be overcollateralized so that they are able to maintain stability of value throughout the market cycles. An example is MakerDAO’s DAI stablecoin, which is pegged to the US dollar but has reserves of Ethereum; and sUSD (sUSD), which is issued by Synthetix, and backed by the Synthetix Network Token (SNX).
• Algorithmic Stablecoins: Unlike the other two stablecoins, algorithmic stablecoins don’t hold any type of reserve; instead, their value is kept stable through an algorithm that regulates their supply — if the price drops, the system reduces the supply, and if the price rises, it increases the supply to maintain its peg. TerraUSD is an example of an algorithmic stablecoin.
• Commodity-Collateralized Stablecoins: These stablecoins are backed by commodities such as gold, silver, or oil, often stored in secure locations or third-party vaults. They combine the best of both worlds of the security offered by traditional assets (notably gold — the safe haven of financial stores?) with the innovations of the blockchain. Examples include Paxos Gold (PAXG) and Tether Gold (XAUT), both are which are pegged to gold.

Stablecoins are pivotal to the backbone of cryptocurrency trading. Nonetheless, stablecoins aren’t so stable after all; given that depegging can occur — this is when a stablecoin breaks away from its pegged value.

Why do Stablecoins Depeg?

• Market Conditions: Just like any other cryptocurrencies, stablecoins are subject to the fundaments of trading, like supply and demand, liquidity, arbitrage etc. A significant selling or buying pressure on a stablecoin will impact its price, particularly when such activity transpires significantly on a specific exchange. Take, for example, TrueUSD (TUSD) which had seen quite a rough start to the year. TUSD used to be one of the assets available for staking in Binance’s famous launchpools, which essentially grants airdrops to users committing cryptocurrencies mainly BNB and stablecoins. The stablecoin was performing well, with minor price fluctuations corresponding to market conditions, right until 18th January 2024 when it depegged from $1 to a low of $0.96, although thankfully the peg has been restored at the time of writing. The depegging corresponded to intense selling pressure on Binance when Binance’s Manta launchpool dropped support for TUSD staking, which in turn saw the rise of FDUSD — Binance’s current darling stablecoin.

Screenshot of coinmarketcap showing TUSD and its depegging on 18/1/24
Screenshot of Binance mobile app — Binance launchpool used to support TUSD staking, which has since been omitted since the MANTA launchpool

Since then, FDUSD has maintained a premium in its trading price, predominantly influenced by Binance’s launchpool listings. Peaks in price fluctuations align closely with launchpool announcements supporting its staking, while troughs roughly correspond to the conclusion of each launchpool staking period, giving a cyclical nature to its price fluctuations which average around its peg of $1.
Screenshot of coinmarketcap showing FDUSD

• Intrinsic failure of the algorithm: UST (Terra) was once a very famous (or infamous?) algorithmic stablecoin that had one of the largest marketcaps. It sought to maintain peg with the USD by means of an algorithmic solution, involving its native token, LUNA. When the price of UST deviated from its peg, the protocol would adjust the supply of LUNA to stabilize the value of UST. If UST’s price rose above $1, holders could burn UST to mint LUNA, increasing its supply and thereby stabilizing UST’s price. Conversely, if UST’s price fell below $1, holders could mint new UST by burning LUNA, reducing its supply and restoring UST’s value to the peg. However, this algorithm had loopholes which were exploited by traders, sparkling a vicious cycle of panic selling and failed attempts to repair the peg. Hyperinflation ensued as investors mass-burned UST, causing a crash which ultimately ended in a death spiral, leading to the collapse of LUNA.

The Downfall of LUNA: 8 Lessons I Learnt From The Terra Fiasco

• Liquidity challenges: Liquidity, crucial for smooth token exchange in any financial market, is pivotal for market stability. Any hiccups, be it network congestion, technical glitches, or security breaches, can disrupt liquidity. These changes, akin to market shifts, can sway stablecoin values, sometimes even causing depegging. For example, USDC lost its peg and fell as low as $0.86 in March following the collapse of Silicon Valley bank, after it was revealed that Circle had a portion of funds backing the stablecoin being held at the beleaguered bank.

• Regulatory concerns: Regulatory updates, especially those concerning cryptocurrencies, can have a notable impact on stablecoin prices, as investors react to news and react accordingly.

So, which is the best stablecoin?

This is a contentious area up for much debate; while no single stablecoin is exempt from its share of rumors, USDT, USDC and DAI have stood the test of time thus far. FDUSD is thriving well thanks to its support for staking in Binance’s launchpools; while Ethena USDe is the latest promising addition to this list.

Screenshot of coinmarketcap showing the top stablecoins by marketcap

While marketcaps do not necessarily correlate with the stability and trustworthiness of any cryptocurrency (UST being an infamous example of such), it gives us a glimpse a picture of its popularity and liquidity. As shown above, Tether wields dominance in the stablecoin market, followed by USDC (into which Binance has recently converted their $1 billion SAFU funds!)

An arbitrage opportunity

Suffice to say, the price fluctuations of stablecoins provide a good arbitrage opportunity for the astute cryptocurrency enthusiast. Take, for example, the price fluctuations of FDUSD before and after a Binance launchpool announcement — if you had bought, say, 1000 FDUSD at a discounted price of $0.9985 in its price steady state prior to the listing, and sold it at a premium of $1.01 upon the commencement of a launchpool period which supports its staking, you would have earned an easy and safe $11.50 from this trade.

Stablecoin: A Misnomer?

Overall, stablecoins can falter due to various factors, and while they are generally more stable than traditional cryptocurrencies, they are not exempt from the fundamental market principles of supply and demand. As a financial instrument, stablecoins provide a convenient and relatively secure means of storing wealth, particularly for investors familiar with the cryptocurrency landscape who wish to hedge their assets in a foreign currency, such as myself. Nonetheless, as the adage goes, “not your keys, not your coins”, the risks of stablecoin, although miniscule, are twofold — loss of assets due to the collapse of a financial platform on which the coins are stored in third party custody, or as a result of the direct depegging of its value. Hence, use cold wallets for amounts not intended for active trading, only invest reasonable amounts with which you are comfortable to lose in cryptocurrency, and be sure to always do your own research diligently!

You may also be interested in the following articles:
How To Earn Crypto With Cold Wallets: An Introduction To Cold Staking
How To Store Your Crypto Securely: The Good, the Bad, and the Ugly
Harvesting Income with Grass: How To Turn Bandwidth into Bucks

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