When a stablecoin that was supposed to always be worth one U.S. dollar, TerraUSD, tanked last week, it sent a shock across the cryptocurrency markets. But did that crash tarnish the entire concept and value of stablecoins?
Some say no, because many existing stablecoins are different from TerraUSD, with better backing and reserves. Others say yes. (Terra itself did not respond to a request for an interview.)
"Of course TerraUSD tarnishes the concept of algorithmic stablecoins,” said Caitlin Long, founder and CEO of Custodia Bank in Cheyenne, Wyoming. “Some of us in the industry have been loudly warning that such a leverage flush was coming.”
Stablecoins should be issued by regulated banks, as federal regulators have recommended, she said.
Stablecoins are cryptocurrencies that are intended to be always worth one U.S. dollar. They are used by traders and investors to buy and sell digital assets using a stable store of value.
The doubt that has now been cast upon whether stablecoins can be counted on as a reliable store of value affects the many banks that have stablecoins in the works, including Silvergate Bank in La Jolla, California, and Custodia Bank. It affects regulated providers of stablecoins like Circle and Paxos. It also affects any bank or investor thinking of using stablecoins to move money digitally or to trade cryptocurrencies.
There are two broad categories of stablecoins. One is dollar tokens backed by assets. Examples of this are USDC (the stablecoin issued by Circle Internet Financial) and USDP (also called the Pax Dollar, from Paxos Trust Co.), which are both backed 100% by cash and cash equivalents such as short-term Treasury bills, their issuers say. The stablecoins being developed by Custodia and Silvergate fall into this category.
The other category is algorithmic stablecoins, which rely on traders’ activity to keep their $1 value. TerraUSD is in this bucket. Its fall from a $1 value was
“No one should be surprised that a very complex, financially engineered structure like TerraUSD would in fact face this kind of loss-of-confidence death spiral,” said Dante Disparte, chief strategy officer and head of global policy for Circle. “Anytime an instrument relies on personal promissory statements on Twitter as the basis of trust and nothing else that can be evidenced, then you're likely trading in something that is exceedingly risky. TerraUSD had more in common with a digital derivative than a stable instrument.”
TerraUSD’s plunge validates concerns Congress and federal regulators have been airing for months about stablecoins: that issuers need to hold more cash in reserves in case there is the equivalent of a bank run on stablecoins that could affect other markets. In a
Banks planning stablecoins are undeterred
But CEO Alan Lane draws a sharp distinction between what his bank is building and TerraUSD. He and others interviewed for this story also seem to be shifting away from use of the term “stablecoin.”
“At Silvergate, we're working to create a tokenized dollar for payments and cross-border remittance use cases,” Lane said. “The Silvergate-issued token will be backed by U.S. dollars held in reserve, managed by Silvergate. Our model differs from existing stablecoins, which are used primarily for crypto-trading use cases and further differentiated from Terra, which is not backed by U.S. dollars.”
The infrastructure Silvergate is building for Diem will let the bank hold U.S. dollar reserves in a capital-efficient manner, Lane said. It will hold a U.S. dollar in reserve for every tokenized dollar represented on the blockchain.
According to Mike Coscetta, head of revenue at Paxos, the TerraUSD collapse creates opportunities for companies like his that have fully backed stablecoins.
“It continues to draw the dividing line thicker and thicker between the fact that there are such things as true stablecoins and then there are such things as variable value” tokens, Coscetta said. “Then there are the ones that are just pure alchemy. Our belief is that a stablecoin should be just that — it should be stable, it should be predictable, it should be transparent. In the worst case, it should operate like a dollar. In the best case, it should operate more efficiently than a dollar.”
The Paxos dollar has never dipped below the value of a U.S. dollar, he said, because every Paxos stablecoin is backed one-to-one with cash or cash equivalents and audited monthly, he said.
As Disparte puts it, not all stablecoins are created equal.
“There are many that are stable in name only,” he said. “It's important to distinguish the difference between stable-in-name-only tokens and regulated stablecoins.”
USDC is 100% backed with cash and short-term U.S. Treasury bills, held in the custody of U.S. regulated financial institutions, including some community banks and minority depository institutions, he said.
“The future of money and payments will be more inclusive than in the past if we start doing slightly different things,” Disparte said. “We want to bring along for the ride the MDIs and the community banks.”
Regulated stablecoin issuers say the rules are there
The notion that all stablecoins are unregulated is overblown, some experts said. For instance, Paxos has a trust charter from New York and a conditional national trust charter from the Office of the Comptroller of the Currency. Its regulator is the New York State Department of Financial Services. If Paxos were to make a change to its stablecoins, it would have to get approval from NYDFS first, Coscetta noted.
Circle has a a BitLicense in New York. It has obtained a money services business license in every state that requires one. If federal rules are issued, Circle will conform, Disparte said.
“When people say stablecoins are unregulated and a Wild West, we're like, ‘Whoa, timeout,’ ” Disparte said. “We're answerable and subject to examinations to remain an actor in good standing.”
If the President's Working Group recommendations were accepted and only regulated banks could issue stablecoins, it’s not clear whether these existing issuers would qualify. Circle has said it is in the process of applying for a national bank charter.
“Stablecoin liabilities should be backed by federal reserves and thus issued by regulated banks, since only Fed reserves can settle as fast as stablecoin liabilities, which settle within minutes,” Long said. “The speed of the run on TerraUSD, which happened in only hours, raises questions about whether even T-bills are appropriate assets to back stablecoin liabilities because T-bill sales settle next day. This situation vindicates regulators who have recently warned about the liquidity risk posed by stablecoins and posited that they should be ring-fenced from deposit insurance funds."
Another thing the TerraUSD collapse has highlighted is the fact that regulation is always trying to catch up with industries, Disparte said.
“And the innovators in the industry will always get ahead,” he said.
But stablecoin issuers like Circle will be fine, Disparte said.
“We do see and expect a flight to quality in this market right now, in which USDC is a trusted asset,” he said.
If TerraUSD had complied with existing rules that govern electronic money, such as segregation of funds in the customer's interest and narrow reserve composition of funds inside a regulated banking system, if it was subjected to state examinations, state oversight, and suspicious activity reporting, the run would not have happened, Disparte said.
