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OPINION

Stablecoin: A cautionary tale of apes, cats and chips

Following Terra’s death spiral, regulators will focus on the collateral backing the biggest stablecoins that are essential to the flow of real money into crypto.

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The bad news keeps on coming for crypto. Euromoney is shocked to learn of a series of flash loan attacks on Sunday against the Feed Every Gorilla (FEG) token. A hacker took advantage of a flaw in the project’s swap mechanism to use the same collateral 10 times over to drain cryptos worth $1.3 million into 10 different addresses.

It is just the latest monkey-business in crypto.

Still, the main cryptocurrency markets staged a modest recovery over the weekend after the death spiral in Terra’s UST, the so-called stablecoin now being quoted as being worth just $0.16.

Let’s recap on stablecoins, because these are the one group of crypto assets that are supposed not to be volatile.

They are the gaming chips in the crypto casino. Investors exchange their real dollars for dollar stablecoins because they can move tokenized dollars more easily between crypto tables and bet on bitcoin, Ether or whatever other decentralized finance (DeFi) protocols they like.

If the big stablecoins can maintain users’ faith and not have to sell collateral, then spillover from the latest crypto panic into real financial markets may yet be quite limited

UST, for example, as part of the Terra ecosystem, was often staked in the Anchor protocol promising investors a 20% yield, which, to the cautious, may have sounded almost too good to be true.

If investors have anything left at the end of the daily spree, they should at least be able to take their few remaining dollar stablecoins back to the house and exchange them one-for-one into real dollars again.

Stablecoin chips are essential to the whole crypto game. The two biggest are Tether (USDT), with a market cap today of $76 billion, and Circle’s USDC, with a market cap of $51 billion. They stand in comparison with the JPMorgan prime money market fund (MMF), the largest such fund, with $70 billion of assets under management at the start of this year.

Terra’s UST had a market cap of $18 billion on May 9. By Sunday, it stood at just $1.8 billion.

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Mike Novogratz, Galaxy Digital

There may still be a future for stablecoins such as Tether and USDC that are backed by actual fiat collateral. UST was an algorithmic stablecoin with a sister token, Luna, of varying price that would allow users to take one dollar’s worth of Luna and buy or sell UST if it slipped to $98 or rose to $102 for a modest arbitrage.

Arbitragers were meant to keep UST stable. Billionaire Mike Novogratz, the former Goldman Sachs partner and founder of Galaxy Digital – a quoted vehicle investing across blockchain and cryptos – who likes to proclaim his enthusiasms for NFTs and other digital assets for the benefit of his followers, had been a fan of the Luna token.

It was the classic faith-based system. Belief in it just collapsed. Conspiracy theories are legion among the crypto crowd, one being that traders dumped it to spread panic, drive the price of bitcoin itself down below $30,000 before loading up on the leading crypto.

Dead-cat bounce?

Dollar stablecoins are meant to maintain a steady value of $1. So, when UST de-pegged last week, it further fuelled the broad sell-off that had already taken the combined market capitalization of all cryptos down from $2.9 trillion in November to $1.54 billion on May 9.

On May 12, the market touched $1.13 trillion before bouncing back up to $1.22 trillion on Tuesday, May 17.

That is still a fall of 58% from the all-time high – the crucial question is whether it is a dead-cat bounce.

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Mark Haefele, UBS global wealth management

Mark Haefele, chief investment officer at UBS global wealth management, says: “As the monetary regime that fuelled the crypto rally unwinds, we think investors should avoid trying to call a bottom on these highly speculative assets.”

Bitcoin, which was worth $46,000 at the start of this year, fell to $26,600 at one point last week, before edging back up to $29,700 on Monday. Like the overall market, it is down 56% from its all-time high.

Where it goes from here, Euromoney has no idea, but Novogratz talked up the comparison with Nasdaq in a risk-off world, when Galaxy reported a $112 million first-quarter loss on May 9.

Novogratz says crypto will trade in a very volatile, choppy and difficult market “for at least the next few quarters”.

At the end of last week, Galaxy provided an update amid the unfolding panic, pegging its losses through the second quarter to May 11 at approximately $300 million. Galaxy says it has $1.6 billion in liquidity, split equally between cash and digital assets, with “the majority” of those net digital assets in non-algorithmic stablecoins.

Terra impact

What will be the impact of Terra’s demise on those non-algorithmic stablecoins? Tether and USDC are different from UST: they are backed by collateral.

Tether, the longest-standing and biggest dollar stablecoin, today displays some basic information on its collateral, the largest portion being in cash and cash equivalents, such as short-term Treasury bills, MMFs and commercial paper (CP) holdings from A2-and-above rated issuers.

On May 12, at the height of the panic, it stated that it was seeing business as usual and had redeemed $300 million of its USDT for real dollars without incident in the past 24 hours and was processing $2 billion that day without issue.

But Tether did briefly touch $0.95 that day before returning to $0.999. The volume of its stablecoins outstanding shrunk from $83 billion on May 11.

Tether has history. The Commodity Futures Trading Commission (CFTC) found in 2021 that, contrary to its claims, it was not 100% fiat-currency backed between June 2016 and February 2019. Today, it reports reserves backing outstanding coins that consist of 6.38% in investments including digital tokens, 5.27% in secured loans, 4.61% in corporate bonds, funds and precious metal, and 83.74% in cash and cash equivalents, including Treasury bills and CP.

Analysts at Bank of America suggest Tether’s CP holdings are non-traditional because no dealer or issuer knows of Tether’s specific flow, adding. “We continue to believe that Tether’s CP holdings are likely acquired through issuance on the blockchain that is not recorded with the SEC or DTCC [Depository Trust & Clearing Corporation]. Tether or other stablecoins could also be acquiring foreign-denominated CP and hedging their US dollar currency risk.”

Circle’s USDC is backed just by cash and US Treasury bills, and this is regularly checked by accountants at Grant Thornton. It was quoted at $1 on Monday.

If the big stablecoins can maintain users’ faith and not have to sell collateral, then spillover from the latest crypto panic into real financial markets may yet be quite limited.

UBS points out that crypto is still not widely held and that only a small number of individuals own most of the market. They now see central oversight as a way to save their casino.

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Mathew McDermott, Goldman Sachs

In future, regulation of stablecoins will likely focus closely on collateral backing. If others collapse – including smaller ones backed by other cryptos, such as Kava’s USDX now trading at $0.81 – only the holders will care.

Fitch says that links between crypto markets and regulated financial markets remain weak, adding: “However, many regulated financial entities have increased their exposure to cryptocurrencies, DeFi and other forms of digital finance in recent months, and some Fitch-rated issuers could be affected if crypto market volatility becomes severe.”

On Monday, Elwood Technologies – a platform aiming to provide institutional-grade access to digital asset markets and liquidity venues – announced it had closed a $70 million Series A funding round, co-led by Dawn Capital and Goldman Sachs.

Other prominent investors include Barclays, CommerzVentures and Novogratz’s Galaxy Digital Ventures.

Mathew McDermott, global head of digital assets at Goldman Sachs, states: “As institutional demand for cryptocurrency rises, we have been actively broadening our market presence and capabilities to cater for client demand.”

Last week’s panic suggests that institutional demand may have passed its peak for now, but crypto has seen plenty of 50% falls and risen again.

Like the classic B-movie monster, it never dies.

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