What are stablecoins, and how do they work? - YouTube

When you think of cryptocurrencies, “stable” probably isn’t the first thing that comes to mind.

In the volatile world of digital assets, prices can go up, or they can go down, often dramatically.

Stablecoins aim to achieve the opposite effect, maintaining a constant value to offer investors

a haven from the intense price fluctuations of bitcoin and other tokens.

Or at least, that's how it should work.

The collapse of one so-called stablecoin, known as terraUSD, has shaken investors' faith in crypto.

It's also set off alarm bells for global regulators, who worry the phenomenon

may hold much broader risks to the financial system.

So, what are stablecoins exactly, and why are they so controversial?

In essence, stablecoins are cryptocurrencies whose value are pegged to an existing asset

— most often the U.S. dollar, though there are others tied to the euro and gold, too.

They’re sort of like casino chips for the crypto world.

Traders buy tokens like Tether or USD Coin (USDC) with real dollars.

Those tokens can then be used to trade bitcoins and other cryptocurrencies.

And whenever someone wants to cash in, they can get the equivalent amount of dollars for

however many stablecoins they want to redeem.

Glen Goodman is a former financial journalist turned crypto investor.

He ran me through the importance of stablecoins to the crypto market.

For any financial market to be efficient, it needs to be liquid, there needs to be a

lot of trading going on, it needs to be functioning smoothly.

The problem is that transferring from fiat currencies like dollars into cryptos is actually a hassle.

It costs money. It takes time.

Stablecoins solve that problem by allowing you to transfer an amount of fiat currency

into an equivalent number of tokens.

And then those tokens can quickly and cheaply be traded in and out on the exchanges. It makes a world of difference.

But, as it turns out, some stablecoins aren't quite as stable as they're made out to be.

Let’s just look at what’s happened to this stablecoin price, the terraUSD price,

look at that absolutely extraordinary, dropped to just 12 cents here, way off its $1 peg.

We saw UST, one of the most popular US dollar-pegged stablecoin projects, totally collapse.

Consumers have gotten hurt real bad this time, and that’s a problem for the whole industry.

It was very much marketed as a stablecoin.

But terraUSD, otherwise known as UST, didn’t hold up to its promise.

Instead of fiat currency reserves, UST relied on a complex set of rules.

If the price of UST sank below a dollar, an algorithm would kick in, creating new units

of a sister coin called luna while taking an equivalent amount of UST out of circulation.

The idea was that this would throttle the supply of the stablecoin and push its price

back up to $1.

Stablecoins are in two different types.

The most easy to understand of those are the ones that are simply backed by, say, dollars.

So you have an equivalent amount of dollars in a bank account somewhere, or things that

are almost the same as dollars like Treasury bills.

The other type are the algorithmic stablecoins.

What they tried to do, was get around the problem of needing tons of collateral, loads of dollars in a bank.

As pressure is put downwards on UST through the mechanisms that work to try and stabilize it,

actually the price of Luna is kind of forced slowly downwards.

And whilst most of the time that system actually kind of works okay and it stabilizes the currency,

in an extreme situation like this one, what happens is it becomes a vicious circle where

UST has got pressure on its peg, it's becoming worth less than $1, the price of Luna falls

further and in the efforts to try and shore up UST, the price of Luna falls even further,

which scares the hell out of people and makes them start selling like crazy.

After UST "broke the buck," Tether also temporarily fell below a dollar on numerous exchanges.

Tether, the world's biggest stablecoin by market value, has long faced doubts over whether

it holds enough assets to support its purported peg to the dollar.

Tether processed more than $10 billion in withdrawals in May as investors got cold feet about the token.

The source of Tether's reserves has been under scrutiny after a series of disclosures showed

it wasn't always backed 1-to-1 by cash as initially claimed.

The big fear with Tether is, what happens if everyone were to start trying to redeem their tokens at once?

Such a scenario would likely mean Tether having to sell off assets it holds, including

commercial paper, a form of unsecured, short-term debt issued by companies.

Tether is still a worry, because if there was a massive run on Tether I'm fairly certain

there wouldn't be enough dollars readily to hand as Tether have admitted some

of their assets are commercial paper, which varies in value over time, and may or may

not be easy to sell on a short-term basis.

For its part, Tether says it is increasing its holdings of US Treasury bills - which

are viewed as safe and easily convertible to cash - while at the same time reducing

the amount of commercial paper it’s sitting on.

Some of Tether's critics also worry it has been used to manipulate crypto prices, a claim the company denies.

I asked Paolo Ardoino, Tether’s chief technology officer, to address some of the concerns surrounding the stablecoin.

Tether did not drop below $1 with its peg.

So, the price of Tether on two or three exchanges went below the dollar because of lack of liquidity.

For the entire time, Tether always honors its redemptions for $1.

Tether, in 48 hours, redeemed $7 billion-plus, that is around 10% of their assets,

without the blink of an eye.

There is no stablecoin, but also there is no bank institution, that has a track record

today successfully redeeming 10% of its assets in 48 hours.

The UST debacle has put regulators on edge.

Governments in the U.S., U.K. and EU want new rules aimed at taming stablecoins, a market

that was worth over $150 billion in the middle of 2022. Larisa Yarovoya, associate professor of finance

at the University of Southampton's business school, said there's an urgent need for stablecoin regulation.

It is very, very hard to police, it’s very hard to control.

We don't have yet any regulation in this area.

If you have a look on the stablecoins, they can appear, be there for four or five months, and after, disappear.

So, the lifespan of certain stablecoins, it's actually very short.

In the U.K., the government has recommended giving the Bank of England powers to

step in if a stablecoin of "systemic scale" ends up failing.

While most economists agree stablecoins aren't yet big enough to pose a "systemic" risk,

they're concerned that could eventually be the case if stablecoins are left to grow to

a point where they become too big to fail — similar to what happened with the 2008 financial crisis.

This gives me nightmares because it takes me back to the Lehman Brothers collapse in 2008.

And everybody was saying the same thing at the time.

The financial world is so complex, that nobody quite understood all these financial Instruments

and how they interacted with each other.

So nobody knew that there was trouble on the horizon because it was too much

for any one human brain to understand.

Similarly, with Terra Luna, the complexity just bamboozled everybody.

I think, in general, all cryptocurrency market participants will benefit from better regulation

of all the assets that are currently in circulation, including stable coins.

I think better regulation will improve transparency and will improve trust in this technology.

If we can offer certain system of auditing, of control, of monitoring,

better requirements on the transparency and disclosure, so I think this really will help everyone.