Why Some Stablecoins Are Crashing and How to Tell the Difference

      Comments Off on Why Some Stablecoins Are Crashing and How to Tell the Difference

Everyone In (And Out Of) Cryptocurrency Felt Terra’s UST Collapse stablecoin when he died, and the aftermath was so devastating that he took down multiple crypto lending platforms, a multi-billion dollar hedge fund, dozens of projects that were built on Terra’s blockchain and 18 billion dollars of people’s money plus 60 billion dollars from the crypto market. While people are now skeptical of crypto and stablecoins because of this tragic event, it is actually a specific type of stablecoin that is collapsing in this way.


Stablecoins are stable cryptocurrencies against the dollar and are fundamentally different from digital currency. Cryptocurrency exchanges have a long history of losing crypto and people’s money due to hacks or management incompetence, so stablecoins were created to avoid holding digital currency in an account. ‘exchange. As long as cryptocurrencies/stablecoins are removed from an exchange, they are safe from exchange problems. Today, stablecoins are the powerhouse of decentralized finance (DeFi), an industry that uses blockchain smart contracts to recreate financial services for cryptocurrencies, and knowing who to trust is key to preserving wealth.

Related: Stablecoin Exchange Curve Finance Hack Explained

Although all stablecoins have the possibility of crashing, the reason and likelihood of this depends on the stablecoin variant. 101 blockchains discusses the three (plus one) types of stablecoins: fiat-backed, crypto-backed, and algorithmic (plus commodity-backed). Fiat-backed stablecoins (USDT, USDC) are backed by cash or “cash equivalents“held in a bank account, and are the most stable. Crypto stablecoins (DAI) are backed by”secured debt positions“, cryptocurrency deposits used as collateral to borrow the stablecoin, and are less stable than fiat-backed stablecoins. Finally, algorithmic stablecoins (UST) are backed by an algorithm that creates or destroys tokens to maintain their peg, and are the least stable.There are also commodity-backed stablecoins, which are similar to fiat-backed but pegged to a commodity.Keep in mind that stablecoins are very different from digital currencies and that digital dollars will not have the same problems or advantages as stablecoins.

What Causes Stablecoins to Collapse?

All stablecoins have some healthy volatility, often fluctuating around 0.01% of $1.00 due to open market buying and selling behavior. They all have the potential to become “deindexed” of the dollar during times of extreme volatility, which occurs when their market value falls or rises by more than 1%, but most can recover their parity. However, some can enter a “death spiral“, which occurs when holders lose faith in the value of the stablecoin and rush to cash in their crypto in a frenzy of panic, crashing the price to zero. Of all three variants, algorithmic stablecoins are almost guaranteed to end up suffering a death spiral, due to having no backing assets that can be redeemed in the event of high volatility, and to date no one has discovered an algorithm that is immune to mass panic.

Often, a simple search on CoinMarketCap or CoinGecko will reveal whether a stablecoin is fiat, crypto, or algorithmic-backed. If it does not say so in the token description, follow the website link and browse its official website to get the answer. If it’s a company that holds money in a bank account and publishes reports on its asset holdings, like Tether’s USDT or Circle’s USDC, then it’s a a fiat-backed stablecoin and will only collapse if the company is found to be lying about its reserves (which regulatory oversight protects). If it’s a DeFi app that allows users to borrow stablecoins against their cryptocurrency holdings, like Maker Protocol’s DAI or Aave’s new stablecoin GHO, then it’s ‘a crypto stablecoin and will only fail under a perfect storm of specific and improbable edge conditions. If it is too complicated to understand and involves no cash reserves or guaranteed cryptocurrency deposits, it is most likely an algorithmic stablecoin and should be avoided.

Avoiding a stablecoin death spiral is quite easy if its variant is known. While this is an oversimplification of how stablecoins work and why they fail, it is useful for avoiding heavy losses from death spirals. In summary, fiat-backed stablecoins are the most stable and durable and are virtually invulnerable, crypto stablecoins are more volatile but still very durable and algorithmic stablecoins will collapse when everyone panics and sells their holdings.

Source: 101 Blockchains, CoinMarketCap, CoinGecko