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Finding stability in stablecoins: The post-crisis future for payments

Stablecoins are facing a crisis situation following the loss of UST’s peg, creating novel challenges for payments projects using the technology.

A red down arrow representing the drop in value of stablecoin UST

Until less than a week ago, stablecoins were considered the safe haven of the cryptocurrency world. 

Able to be quickly converted into other digital currencies, sent to other users around the world and even used to generate interest through a variety of distributed finance initiatives, they have been increasingly embraced by many players in the crypto space. Investors looking for a volatility-free way to hold assets have turned to stablecoins, as have companies looking to offer crypto-based services such as remittances without the risk of a sudden value spike.

However, the events of the last week have cast significant doubt on the viability of stablecoins as the safe choice for digital currencies. 

Inside the stablecoin crisis

First, TerraUSD, also known as UST, experienced a sudden and dramatic collapse. A number of large sell orders coincided with lower-than-normal liquidity, which itself was caused by an in-progress attempt by maker Terra to increase interoperability between different stablecoins.  

There have been rumours that this was the result of a targeted attack, although at present there is no conclusive evidence to support this. Regardless, the result was that UST quickly lost its peg, with Luna, the token that is minted or burned whenever UST is created or sold, collapsing to just above $0.

As the collapse caused a significant upswing in buy/sell activity among stablecoins, others began to also see issues. DEI, which is produced by Deus Finance, also saw a similar, but less severe, impact, dropping to a low of $0.52 before recovering slightly. At the time of writing, it was trading at around $0.59.

Tether (USDT), the largest stablecoin by circulation, also lost its peg for a short period, dropping to $0.95 before recovering.

As volatility continues to spread among stablecoins, the world of finance – including the payments industry – is beginning to grapple with the issue. The last week’s events have caused immense harm to the public perception of stablecoins as a reliable, trustworthy way to digitise money, and so significantly jeopardise ongoing payments efforts in the space. 

Daily close price of UST, USDT and DEI stablecoins, showing that UST and DEI have lost their peg and have not recovered as of 17 May

Cross-border payments and stablecoins: The industry’s exposure

The crisis comes as the cross-border payments industry is increasingly exploring the potential benefits of cryptocurrencies, in particular through the use of stablecoins. 

MoneyGram, for example, is currently trialing crypto remittances through a partnership with Stellar, which sees it use USDC, the second largest stablecoin by circulation, which is powered by Circle. CEO Alex Holmes characterised the project as creating new opportunities for MoneyGram to provide crypto-fiat interoperability, enabling the company to become a “global exchange” between the two.

Facebook’s parent Meta, meanwhile, has also used stablecoins to make a play in the remittances space, with its Novi brand currently providing instant money transfers between the US and Guatemala using Paxos’s USDP stablecoin.

Payments giant PayPal has also said it is developing a stablecoin, which is expected to be used for consumer remittances, while a consortium of US banks are currently developing their own stablecoin, USDF, for P2P and B2B money transfers.

The potential of cryptocurrencies for consumer remittances has been a matter of debate, with some, such as Intermex CEO Bob Lisy, questioning how much consumers are likely to embrace the potential additional complexity of the technology.

However, few have questioned the use of stablecoins themselves. The stability of stablecoins has been accepted by the industry with little to no questions, and so this crisis poses a novel threat to the utility of digital currencies in payments. 

Across the space, but particularly in consumer payments, trust is absolutely vital to the adoption of new financial services. It’s why premium remittance brands are able to attract consistent and dedicated customers, and without it, any new project is doomed to failure. 

Brands wishing to work with stablecoins therefore need to ensure that they are effectively combating concerns, while stablecoin makers themselves need to ensure they are making a strong case for why their stablecoin can’t suffer the same rate as UST.

Key example projects using stablecoins for cross-border payments

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Algorithmic versus reserves: How the crisis is creating a trust divide in stablecoins

Among many stablecoin makers, the campaign to restore trust has already begun, and in the process, a clear divide is emerging in how stablecoins are backed. 

Essentially, not all stablecoins are created equal. Some, such as USDC and USDP are backed by cash and cash equivalents, meaning that for every stablecoin in circulation the company holds a US dollar to back it.

However, UST was not backed by a reserve, but instead used algorithmic backing based on Terra’s Luna token. This was what enabled it to collapse – if it had instead been reserve-backed it is unlikely it would have lost its peg so dramatically. And this fact has been seized upon by stablecoin makers courting enterprise partnerships as they seek to distance themselves from the situation.

Circle CEO Jeremy Allaire, who is pursuing a B2B focus when it comes to customer acquisition, has called for greater regulation of the market to prevent similarly at-risk stablecoins being developed in future, arguing that “​​what has unfolded with these unstable stablecoins was entirely predictable”.

Circle’s CFO Jeremy Fox-Geen also put out a post clarifying the makeup of USDC’s reserve, which was of 13 May was 22.9% cash as 77.1% US treasuries.

Charles Cascarilla, CEO of Paxos, also criticised algorithmic stablecoins, telling CNN that they are “just a fancy way of saying, ‘We are going to say that this is worth a dollar because it’s backed by another asset that we also create out of thin air.” Paxos powers both USDP and Binance’s stablecoin BUSD, the ninth and third largest stablecoins by circulation respectively. 

It is likely that stablecoins that see long-term success will not only be fiat-backed, but be provably and transparently so. USDT maker Tether has previously received criticism for this, after it emerged that some of its reserve holdings were in commercial debts, not fiat currency or treasury bonds.

Key features of leading US dollar-pegged stablecoins

Creating a stable future: Can regulations save stablecoins’ role in the future of payments?

There have already been numerous calls for greater regulation of the cryptocurrency space, and the stablecoin crisis is only going to increase the justification for increased transparency, standards and controls. 

Some users with large holdings in Luna and UST are reporting losses of over $100,000, and under current regulations they are unlikely to have any chance of recouping this money. 

For fiat-based payments companies, and others across the financial services industry, ensuring their stablecoin partners are properly regulated will be more essential than ever to ensure that they are protecting themselves from risk and reassuring their shareholders.

However, it is possible that the current situation could ultimately create a perception among regulators that for-profit stablecoin makers are not to be trusted, and that the best approach would be to instead restrict such digitisation of currencies to banks. Central bank digital currencies are in development all over the world, and with stablecoins increasingly being proposed as the future of money, CBDCs may ultimately be seen as a better way to retain security, trust and financial sovereignty.

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