Stablecoins are a relatively new phenomenon in the world of cryptocurrencies, having emerged in the wake of the 2017 cryptocurrency boom. The first stablecoin, Tether (USDT), was launched in 2014, but it was not until 2017 that stablecoins gained widespread attention.
Stablecoins were born to address the volatility issue of cryptocurrencies and provide the stability of traditional currencies like the US dollar, while still taking advantage of the speed, security, and transparency of blockchain technology.
The volatility of cryptocurrencies like Bitcoin and Ethereum has been a significant barrier to their mainstream adoption, as their value can fluctuate wildly in a matter of hours or even minutes. Stablecoins work by pegging their value to an underlying asset or a basket of assets, such as the US dollar, gold, or other cryptocurrencies.
The most common type of stablecoin is the fiat-collateralized stablecoin, which is backed by a reserve of traditional currencies, typically the US dollar. For example, Tether (USDT) is pegged to the US dollar, with each USDT token backed by one US dollar held in reserve. Other fiat-collateralized stablecoins include USD Coin (USDC), Paxos Standard (PAX), and TrueUSD (TUSD).
Another type is the algorithmic stablecoin, which uses complex algorithms and smart contracts to maintain stability. These stablecoins do not rely on a reserve of traditional currencies but instead adjust their supply dynamically based on market demand. Examples of algorithmic stablecoins include Dai (DAI) and TerraUSD (UST).
Cryptocurrencies vs Stablecoins volatility
Stablecoins and cryptocurrencies differ significantly in terms of volatility. Cryptocurrencies, such as Bitcoin and Ethereum, are known for their extreme price volatility, with prices sometimes fluctuating by tens of percentage points in a single day. Stablecoins, on the other hand, are designed to maintain a stable price and avoid the extreme fluctuations of cryptocurrencies.
As said before, the value of a stablecoin is typically pegged to a stable asset and is designed to remain relatively stable over time. This stability is achieved through a variety of mechanisms, including holding reserves of the underlying asset, adjusting the supply of the stablecoin based on market demand, or using a combination of both.
By contrast, cryptocurrencies are not backed by any tangible asset and their value is determined solely by market demand. This means that their value can fluctuate widely based on factors such as news events, changes in regulations, and overall market sentiment.
It’s worth noting, however, that stablecoins are not completely immune to volatility. Even stablecoins that are backed by traditional currencies can be subject to fluctuations in the value of those currencies, particularly in times of economic uncertainty. Additionally, stablecoins that are not fully collateralized or that use complex algorithms to maintain price stability may be subject to greater volatility. Nonetheless, stablecoins remain a useful tool for those looking to reduce their exposure to the volatility of the cryptocurrency market.
Stablecoin past drops
Even stablecoins are subject to risks and uncertainties and have experienced price crashes or other issues over the years; one example is the stablecoin Tether (USDT), which faced a loss of confidence and a subsequent price drop in 2018, due to concerns about whether Tether was fully backed by US dollars. As a result, the price of USDT briefly fell below its pegged value of $1. Another example is the stablecoin DAI, which is backed by collateral in the form of other cryptocurrencies. In March 2020, a severe market downturn led to a sharp drop in the value of the underlying collateral, causing the value of DAI to temporarily fall below its pegged value.
One of the most recent shocking events is the TerraUSD crash in May 2022, when a withdrawal of deposits on the Anchor protocol of the TerraLuna system suddenly started, dropping from 14 billion to 3 billion, and then falling even further.
Given the suspicious speed with which all the funds started to be withdrawn, even the algorithm of a stablecoin designed to keep the price fixed failed to react in time: the value of TerraUSD dropped to 70 cents and then to 16 cents in the following days.
Crash events correlation
Stablecoins and cryptocurrencies can be correlated in crash events, but the degree of correlation can vary depending on the specific circumstances and a variety of factors. In some cases, stablecoins may experience a crash alongside cryptocurrencies if investors start to lose confidence in the overall cryptocurrency market. For example, if there is a sudden downturn in the price of Bitcoin, investors may sell off their holdings of stablecoins as well, leading to a drop in the price of stablecoins.
However, in other cases, stablecoins may serve as a haven during cryptocurrency crashes, as investors look for a stable asset to hold during times of volatility. This was seen during the market downturn in March 2020, when the price of Bitcoin and other cryptocurrencies fell sharply, but stablecoins such as Tether and USD Coin remained relatively stable.
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