Over the past week, we’ve learned that stablecoins aren’t really all that stable.
The major stablecoin terraUSD – more commonly referred to as UST – officially lost its peg to the U.S. dollar, causing a catastrophic devaluation in its accompanying cryptocurrency, LUNA. Eventually Terra’s blockchain was frozen, it was delisted from most major exchanges, and the luna coin’s value declined to zero.
This week, instability has already been noted in other major stablecoins, notably DAI.
But that doesn’t mean stablecoins themselves are a doomed concept, says Ian Epstein, president of Enigma Securities, a digital broker-dealer serving institutional wealth clients.
Stablecoins vs. algorithmic stablecoins
“We should talk about what I think of as a stablecoin versus what is really another bad idea dressed up as a stablecoin,” said Epstein. “Terra and some of these other coins may call themselves algorithmic stablecoins, but that’s really more of a fancy word for a leveraged position that purports to be the asset backing for a stablecoin.”
When the leveraged assets can no longer keep up with the stablecoin’s liabilities, the structure collapses.
It’s a scenario familiar to Epstein, who spent a decade of his career as a macro portfolio manager at Autonomy Capital.
“We see emerging markets all the time that have a peg to the U.S. dollar, but where the liabilities of the central bank do not equal the assets side of their balance sheet, their reserves,” said Epstein. “That puts excess pressure on the peg and causes the devaluation of their currency.”
When Terra’s asset balance tipped too far towards liabilities, it caused the digital economy equivalent of a “run on the bank,” said Epstein. “These were Ponzi-like, poorly structured ideas that remind me of every other failed currency peg historically.”
Terra’s great failure was using non-dollar reserves to defend a dollar peg, according to Epstein, but other stablecoins show more promise for actual stability and staying power.
“The USD coin (or USDC) stablecoin is a money market-like digitization of the dollar run by a company called Circle,” said Epstein. “It’s quite transparent – it is truly a stable stablecoin using technology not to gain things. Circle is not trying to use tractional reserve or leverage. A digital form of the dollar serves a utility function, they’re offering that product and not trying to be overly greedy. They’re playing by the rules as they understand them. That’s a stablecoin.”
Circle uses high-quality short-term paper as an asset to back the USDC token, said Epstein.
Stablecoins have staying power
From a broker-dealer perspective, Epstein sees the value potential in a stablecoin serving as a transparent, fully backed digitized money market fund. “There’s great transparency and ease in subscribing to it and it provides a great value, as will other true stablecoins similar to USDC that will come about in other currencies over the next six to 12 months.”
Epstein’s institutional clients are also closely scrutinizing the stablecoin space. As interest rates and yields increase, stablecoins’ balance sheets should improve in health.
The incentive to create a true stablecoin as a regulated and transparent entity remains intact despite the negative headlines surrounding stablecoins, said Epstein.
Others, like AdvisorBId founder Brandon Spotswood, think the collapse of Terra and issues with other stablecoins will bring in stricter regulation and may cause central banks to accelerate work on their own digital currencies.
DeFi: Another area of interest
It might be hard to wrap your brain around institutional interest in decentralized finance (DeFi), technology built to disintermediate the financial transactions that have built many of the world’s financial institutions, but Epstein said the interest is there.
Institutions are drawn to DeFi by the efficiencies created by smart contracts, which make possible a trustless exchange with no third-party intermediaries ensuring the exchange of assets, and instantaneous settlement of transactions at any time.
“Think about all the economic rents that are derived by firms engaged in that sort of activity, and it was a very important activity, creating trust bridges,” said Epstein. “Now, smart contracts do that for us automatically. Think about how long it takes to settle a transaction, and what percentage of the year the market is open. Everything will now settle instantaneously, markets can function for 100% of the year, and decentralized finance makes it all possible. There’s a lot of value in that, and it has nothing to do with algorithmic stablecoins.”
Institutions still take baby steps
Along with the stunning collapse of UST and LUNA, the crypto space continues to experience volatile price swings – an issue that may play into the hands of sophisticated investors like the hedge funds, asset managers and other institutions served by Enigma.
These investors are still gearing up their crypto efforts and building investment mandates, said Epstein, and most of them suffered few losses in the recent downdraft as they have yet to put most of their capital to work.
“For major institutions, they’re no more affected in digital assets than they are right now in fixed income, where credit markets have had a difficult run, or in technology, which is also down a fair bit, or in emerging markets which are down as well,” said Epstein. “There are some concerns that the prices and valuations they were looking at previously were going to be difficult to justify. With a repricing of these markets, in some ways it’s to their advantage as they are further along in their aggregation of human intellectual and financial capital to put to work in this space.”
Financial capital moves quickly, said Epstein, especially in frothy markets as it tries to find safety and value. Human capital is more likely to tell the full story.
“Never before have I seen so much human capital aggregated into one space – financial capital always goes into all kinds of things, markets go up and down – but human capital, sheer geniuses moving into a space and thinking about ways to leverage the technology, that is the most important sociocultural phenomenon in digital assets,” said Epstein. “Because of that, institutional interest and adoption will not abate. The price of bitcoin [BTC] is of less importance.”
CoinDesk is an award-winning media outlet that covers the cryptocurrency industry. Its journalists abide by a strict set of editorial policies. In November 2023, CoinDesk was acquired by the Bullish group, owner of Bullish, a regulated, digital assets exchange. The Bullish group is majority-owned by Block.one; both companies have interests in a variety of blockchain and digital asset businesses and significant holdings of digital assets, including bitcoin. CoinDesk operates as an independent subsidiary with an editorial committee to protect journalistic independence. CoinDesk offers all employees above a certain salary threshold, including journalists, stock options in the Bullish group as part of their compensation.