What are stablecoins and how did they trigger a crypto market crash

What are stablecoins and how did they trigger a crypto market crash?

Stablecoins promise a safe haven from the wild price swings of cryptocurrencies. But the collapse of stablecoin TerraUSD has called that idea into question.

The prices of popular cryptocurrencies like Bitcoin, Ethereum and the wider crypto market plunged last week, triggered by the crash of so-called stablecoins, a type of cryptocurrency that is supposed to protect buyers from the volatility of digital currencies.

Market Crash

Hundreds of billions of dollars were wiped off crypto’s total market cap, wrecking portfolios as holdings of the TerraUSD (UST) stablecoin and its sister token Luna dropped to almost zero from a combined value of more than $40 billion just before their fall.

The collapse of the Terra blockchain project – which simultaneously played the role of mint, commercial bank, central bank, and even stock market – had many calling it the crypto world’s “Lehman moment.”

The downfall of the Terra token economy, widely viewed as one of the biggest experiments in decentralized finance (DeFi) to date, saw investors cut their losses and move their money to less volatile assets.

Terra had lured in some of the biggest names in crypto onto its blockchain, the likes of Galaxy Digital, Coinbase Ventures, Jump Crypto and many others, not to mention a number of retail investors that ended up posting their despair on social media.

What are stablecoins?

Stablecoins are a form of cryptocurrency that is tied to a reserve asset such as a currency (like the dollar or euro) or a commodity (like gold, oil, or real estate), so as to make the value of stablecoins less prone to volatile swings in price.

For example, Tether (USDT) is pegged to the US dollar, while Pax Gold is tied to gold prices.

This differs from other cryptocurrencies like Bitcoin, which are not backed by anything.

There are different types of stablecoins, too.

First, you have fiat-backed stablecoins like USD Coin (USDC), where for every $1 in USDC there is $1 held in a bank.

Then you have stablecoins which are backed and collateralised by crypto, where for interest-bearing crypto assets, you get stablecoins like Dai or Mim.

Lastly you have algorithmic stablecoins like UST, which are under collateralised, most of which are based on arbitrage opportunities when the coin is “off” the $1 peg.

Investors use stablecoins to protect their money from sudden price swings associated with other cryptocurrencies. On DeFi platforms, stablecoins are used to lend crypto, since the value of the collateral or currency-baked tokens is unlikely to change between the time a customer gets approved for a loan and the crypto lands in the individual’s digital wallet.

Traders also use stablecoins instead of converting more volatile assets into hard cash, which can be expensive and trigger tax implications.

There are roughly 200 varieties of stablecoins on the market, with the three largest by market value being Tether ($74 billion), USDC ($52 billion) and Binance USD ($18.5 billion).

As of Friday, the total market value of stablecoins was $160.6 billion, according to CoinMarketCap.

Source: TRT World