Depegging, Bank Runs and Unstablecoins

2023-04-10, 02:35

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## [TL; DR]
The bank run of Silicon valley Bank (SVB) triggered a series of stablecoin depeg.

USDC, <a href="/price/trueusd-tusd" target="_blank" class="blog_inner_link">TrueUSD</a> (TUSD), <a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a>, <a href="/price/pax-dollar-usdp" target="_blank" class="blog_inner_link">Pax Dollar</a> (USDP) are examples of stablecoins that depegged after the collapse of Silicon Valley Bank.

The four types of stablecoins are fiat backed stablecoins, commodity backed stablecoins, crypto-backed stablecoin and algorithmic stablecoins.

The risks which every stablecoin faces depend on the nature of its reserves.

## Introduction 
The year 2023 had a promising beginning in terms of cryptocurrencies as they performed well. Most of the major cryptocurrencies gained significantly during the first two months, with <a href="/price/bitcoin-btc" target="_blank" class="blog_inner_link">Bitcoin</a> continuing with its rally. However, the recent bank runs (Silvergate Bank, Signature Bank and Silicon Valley Bank) caused several stablecoins to depeg.

## A volatile month for stablecoins 
A number of stablecoins depegged following the collapse of the Silicon Valley bank (SVB), something that indicates the inherent risks in them. Depegging of stablecoins occurs when their prices fall below their stated values. Basically, a stablecoin should maintain a fixed value such as $1.00.

The first stablecoin to depeg was the U.S. Dollar Coin (USDC), the number 3 ranked stablecoin, whose value dropped to $0.87. However, it has since regained its 1.1 peg to the United States dollar. USDC depegged after Silicon Valley Bank failed to process a transfer of $40 million which Circle, the issuer of USDC, had request

During the period of the USDC sell-off, DAI, a crypto-backed stablecoin also depegged, its value fell by 2.0%. DAI, the Maker Protocol stablecoin, depegged because USDC is one of the assets which backs it. The other cryptocurrencies that back DAI are ETH and <a href="/price/pax-dollar-usdp" target="_blank" class="blog_inner_link">Pax Dollar</a> (USDP). In the end, the value of DAI, with a market capitalization of $5.7 billion at that time, dropped to $0.897. Nevertheless, it regained its peg within a short period.

The above graph shows the point where USDC depegged. Notably, there was a domino effect on several stablecoins like <a href="/price/trueusd-tusd" target="_blank" class="blog_inner_link">TrueUSD</a> (TUSD), <a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a> (<a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a>), and <a href="/price/pax-dollar-usdp" target="_blank" class="blog_inner_link">Pax Dollar</a> (USDP), which all lost their pegs. The value of the <a href="/price/usdd-usdd" target="_blank" class="blog_inner_link">USDD</a>, a stablecoin issued by <a href="/price/tron-trx" target="_blank" class="blog_inner_link">TRON</a>, fell by 7.5% to $0.925. On the other hand, the price of <a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a> (<a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a>) - a fractional-algorithmic stablecoin- decreased to $0.885.

Although <a href="/price/tether-usdt" target="_blank" class="blog_inner_link">Tether</a> USDT also depped, it did that in a positive way as its value rose to $1.06 due to a rise in demand. This is because, during that period, many investors considered it a better stablecoin than the others.

## Bank runs
The recents bank runs, Silvergate Bank, Signature Banks and Silicon Valley bank, and the subsequent depegging of several stablecoins have shown the risks which these cryptocurrencies have. It has also indicated the interconnectedness that exists between the traditional banking system and fiat-backed stablecoins. The reason for this connection is that banks hold the reserves that back the stablecoins.

Now, what exactly is a bank run? A bank run occurs when many depositors withdraw their funds in large amounts, fearing that the bank will be unable to give them their money when they need it. This creates a big problem for the bank since they only hold a small fraction of the deposited money at any time as they lend much of the deposited funds.

In most cases, the banks use the depositors’ funds to purchase interest bearing investment instruments like government bonds. Therefore, when many depositors withdraw much money within a short period the banks are forced to sell their assets. If they sell the assets at loss they may become insolvent.

Unfortunately, when the banks become insolvent they are forced by the law to close down which usually locks the funds that back stablecoins. If the market learns that the funds that backs a certain stablecoin is locked within a bank they sell off their holdings which result in its depegging. Therefore, bankruns threaten the stability of stablecoins like USDC and BUSD.

## Recent depegging threats
The threats of stablecoin depegging have been there since the collapse of the <a href="/price/terra-luna" target="_blank" class="blog_inner_link">Terra</a> USD (UST) in May 2022, an event which pushed the crypto market further into a bear run.

According to Whale Alert, a blockchain analytics firm, the last part of 2022 witnessed large redemptions of stablecoins. stablecoin redemption means swapping the cryptocurrency for its collateral such as the United States dollars. This results in a decrease of its market capitalization.

Between November 2022 and 10 February 2023 there was a total redemption of stablecoins worth $9.8 billion, equivalent to 7.23%. By that time, the redemption of BUSD represented 31% of that total figure. As a result, there was a huge decrease in the dominance of stablecoins in the market. Specifically, in the last three months the value of the stablecoins in circulation decreased by about 16.5%, equivalent to about $10 billion.

One of the USDC risks is the type of securities that back it. Overall, about 80% of the stablecoin collateral is in the form of 30-day fixed maturity treasury bills. This means that only 20% of the fiat collateralized stablecoins is liquid cash. It is this misnomer with fiat-collateralized stablecoins that creates an additional threat.

## Depegging and cash reserves
As you noted above, the type of collateral for a pegged crypto determines its ability to resist crypto depegging. Normally, the values of stablecoins may fluctuate slightly from the peg, for example by a few cents. Nevertheless, large fluctuations from their established values lead to depegging.

The valuations of the collaterals that back the stablecoins depend on changes in their prices and the cost of converting them to cash. Some of the underlying assets are secured loans, corporate bonds and precious minerals, especially gold.

A report on <a href="/price/tether-usdt" target="_blank" class="blog_inner_link">Tether</a> stablecoin (USDT) dated December 2022 indicates that it has 58.5% of its cash reserves in Treasury Bills with an average maturity age of 60 days. Similarly, the reserves of USDC and BUSD are in bonds and cash deposits. The differences in the reserve ratios of these stablecoins determine their risks.

## Types of stablecoins
The types of stablecoins determine the risks inherent with them. We have four types of stablecoins namely fiat-backed stablecoins, commodity-backed stablecoins, crypto-backed stablecoins and algorithmic stablecoins.

**Fiat backed stablecoins**: These are stablecoins which are backed by a fiat currency such as the United States dollar. Each stablecoin is tied to a certain currency in a 1.1 ratio. For example, <a href="/price/tether-usdt" target="_blank" class="blog_inner_link">Tether</a> USDT is pegged to the United States dollar in a 1.1 ratio. This means that the value of each USDT is $1.00 unless it has depegged. With crypto pegging, the issuer keeps enough reserves for all the coins in circulation.

**Commodity backed stablecoins**: These are stablecoins which are backed by commodities such as precious minerals or real estate. However, most of the existing stablecoins like Paxos Gold (PAXG) or <a href="/price/tether-gold-xaut" target="_blank" class="blog_inner_link">Tether Gold</a> (xAUT) are backed by gold. In this case, the stablecoin issuer should keep a reserve of the underlying assets.

**Crypto backed stablecoin**: As the name suggests, these are stablecoins which are backed by other cryptocurrencies. Dai, backed by USDC, ETH and <a href="/price/pax-dollar-usdp" target="_blank" class="blog_inner_link">Pax Dollar</a> (USDP) is a good example of such a stablecoin.

**Algorithmic stablecoins**:  These stablecoins, also called non-collateralized stablecoins, are not backed by any asset. The value of the stablecoin is maintained using an algorithm that controls its supply and demand.

If the value of the stablecoin rises above the set price the protocol mints new coins. This increases its supply and reduces its price. On the contrary, if its value falls below the established price the protocol burns some of the coin, thereby decreasing its supply. This results in an increase in its value

## The case of BUSD
In February 2023, the Securities and Exchange Commission (SEC) issued a Wells notice to Paxos, alleging that BUSD is an unregistered security. This Wells Notice, a letter which informs a company of a planned law enforcement, showed that SEC was investigating BUSD.

Initially, Paxos disagreed that BUSD was not a security under the Federal securities law. Nevertheless, it later agreed to stop minting BUSD. Due to the SEC's investigation and Wells Notice, Paxos discontinued its partnership with Binance. Although the SEC's action did not lead to serious market reaction, it shows how law enforcement against a stablecoin can become a threat.

## Conclusion 
In summary, several stablecoins lost their pegs so far in 2023. This includes the USDC depeg which had a domino effect on the other stablecoins like DAI, <a href="/price/trueusd-tusd" target="_blank" class="blog_inner_link">TrueUSD</a> (TUSD), <a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a> (<a href="/price/frax-frax" target="_blank" class="blog_inner_link">Frax</a>), and <a href="/price/pax-dollar-usdp" target="_blank" class="blog_inner_link">Pax Dollar</a> (USDP). That string of crypto depegging was a result of the collapse of Silicon Valley Bank.

## FAQs about stablecoins
**What are the top ten stablecoins?**

The top ten stablecoins are <a href="/price/tether-usdt" target="_blank" class="blog_inner_link">Tether</a> USDT, <a href="/price/usd-coin-usdc" target="_blank" class="blog_inner_link">USD Coin</a> (USDC), <a href="/price/binance-usd-busd" target="_blank" class="blog_inner_link">Binance USD</a>(BUSD), Dai (DAI), <a href="/price/trueusd-tusd" target="_blank" class="blog_inner_link">TrueUSD</a>(TUSD), <a href="/price/pax-dollar-usdp" target="_blank" class="blog_inner_link">Pax Dollar</a> (USDP), <a href="/price/usdd-usdd" target="_blank" class="blog_inner_link">USDD</a>, <a href="/price/gemini-dollar-gusd" target="_blank" class="blog_inner_link">Gemini Dollar</a> (GUSD), Fei USD (FEI) and <a href="/price/terraclassicusd-ustc" target="_blank" class="blog_inner_link">TerraClassicUSD</a> (USTC). All these cryptocurrencies are established and listed on various crypto exchanges.

**What are the two main types of stablecoins? **
The two main types of stablecoins are fiat-backed stablecoins and crypto-backed stablecoins. Fiat-backed stablecoins are cryptocurrencies whose values are pegged against fiat currency such as the United States dollar. Crypto-backed stablecoins are stablecoins backed by other cryptocurrencies like BTC.

**How many stablecoins are there? **
CoinMarketCap has a list of139 stablecoins. However, the total number of stablecoins may be higher since some of them are not yet listed on exchanges.

<div class="blog-details-info">
<div>Author:** Mashell C.**, Gate.io Researcher
<div class="info-tips">\*This article represents only the views of the researcher and does not constitute any investment suggestions.
<div>\*Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all cases, legal action will be taken due to copyright infringement.
</div>

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