Billions in USDT removed from circulation

Billions of dollars' worth of USDT vanishes in light of the TerraUSD collapse, and the ensuing market panic.

Amid the panic over the collapse of TerraUSD, investors withdrew over $7 billion dollars worth of Tether - raising fresh fears about Tether's ability to back each coin with a dollar. Tether's market cap has declined by almost 30 percent since its peak in January, and its price is now substantially below the reported value of $1. At the time of writing, Tether's circulating supply has slipped from about $83 to less than $76 billion within one week.

Tether's questionable track record has caused investors to doubt the validity of stablecoins that are backed by dollars. As a result, investors have been pulling their funds out of stablecoin wallets. Clearly, investor confidence in Tether has eroded considerably since its peak.

TerraUSD, USDC, Tether, BUSD, DAI stablecoins
Are stablecoins still safe?

What is a fiat-collateralized stablecoin?

A fiat-collateralized stablecoin is a digital asset whose value is based on fiat currencies such as US dollars or Japanese yen. This value is pegged to the underlying currency, and backed by the collateral held by the stablecoin issuer. This collateral usually comes in the form of real-world assets like cash deposits, bonds, or gold.

Every time a user deposits USD into their issuer's reserve, new stablecoins are minted. Similarly, when the user makes a redemption request, the issuer will send the provider USD and burn the redeemed stablecoin. This mechanism ensures that stablecoin's price doesn't fluctuate, by distributing or burning a stablecoin's supply when the price is too volatile.

One limitation of fiat-collateralized stablecoins is that they require massive amounts of capital to foster legitimacy and trust, and their ability to remain stable depends on the amount of collateral held by third-party custodians. This amount should be sufficiently large in the event that a huge number of investors decide to withdraw their funds within a short time period. This mechanism differs from algorithmic stablecoins (i.e. UST, ESD, etc.) which use smart contracts to respond to supply and demand by buying, selling and/or burning tokens to maintain a peg.

Tether peg to US dollar
There was a noticeable de-pegging in the value of Tether in mid-May.

Why stablecoins need regulation

On its site, Tether describes itself as an “independently audited cryptocurrency that is fully collateralized by traditional currency held in our reserves.” However, after a previous settlement with the New York attorney general, the company revealed that the collateral is not entirely in cash, and includes commercial paper - a form of short-term, unsecured debt issued by companies - to support its token. This information continues to cause doubt in stablecoins by perpetuating a fear of loss in investors.

Furthermore, Tether has admitted that it does not have dollar deposits at U.S. banks to back up its tokens, and representatives have stated that the company is working to create dollar deposits at multiple banks. However, Tether has so far been unable to do this, and its current dollar deposits are reportedly not sufficient to fully collateralize its tokens. Should Tether be unable to obtain enough dollar deposits to comply with the proposed regulations, it would be forced to stop issuing USDT tokens and trading on exchanges. This would cause a sudden drop in the price of USDT on exchanges and likely trigger a panic selling event. This could drive the price of bitcoin and other cryptocurrencies down even further, as traders sell off their holdings to avoid further losses on other digital assets and fiat currencies as well.

Despite the recent price drops, USDT remains popular in the market, with USDT holding over 80% of the stablecoin market by market cap. The coin has continued to gain investors despite its transparency issues, but the recent wave of panic-driven regulation could change that.

Senator Toomey speaking
Sen. Toomey proposing a stablecoin regulatory framework.

Stablecoin TRUST Act Underway

Last month, Sen. Pat Toomey released a discussion draft of legislation establishing a new regulatory framework for payment stablecoins. "The discussion draft released represents the latest effort to develop more concrete rules of the road for stablecoins, a relatively new innovation in the financial marketplace that has garnered significant attention in recent months," Toomey said in a joint statement with Sen. Mark Warner, a co-sponsor of the bill.

“While today stablecoins facilitate trading with cryptocurrencies, tomorrow stablecoins could be widely used in the physical economy. They have the potential, among other things, to speed up payments and automate transactions,” Toomey added. “The proposed regulatory framework I’m releasing today will allow this crypto-innovation to continue flourishing while protecting consumers and minimizing potential risks from stablecoins to the financial system."

Under Toomey’s bill, most stablecoin issuers would be required to disclose the precise assets that back the stablecoin and how the redemptions work. Providers will also be subjected to routine auditing by registered public accounting firms.

The bill would also require "tethered" stablecoins to "maintain a one-to-one relationship with a U.S. dollar held in an account at a U.S. bank."

It’s worth noting that Toomey has not formally introduced the draft legislation. Instead, he is announcing it for public comment and feedback, meaning that any final version could vary significantly before a formal introduction.

While not yet large enough to cause disruption in the economy, stablecoins like Tether might one day become large enough that its assets in the U.S. Treasurys become “really scary,” Carol Alexander, a professor of finance at Sussex University, said.

“Suppose you go down the line and, instead of $80 billion, we’ve got $200 billion, and most of that is in liquid U.S. government securities,” she said. “Then a crash in Tether would have a substantial impact on  U.S. money markets and would just tip the whole world into recession.”

The continued growth of stablecoins comes with significant risks that need to be addressed before stablecoins become more mainstream. In light of these risks, regulators should increase oversight of stablecoins and impose stricter regulations to prevent manipulation and price volatility.

However, despite the threat of pending legislation on stablecoins, and the fear that surrounds their use - there continues to be strong indicators that they will prevail, and eventually reach mainstream adoption.


DISCLOSURE:

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. Charts, graphs and references to any digital assets are for informational and illustrative purposes only.

Finblox Blog is associated with Finblox - a reliable cryptocurrency earnings platform where you can buy and earn passive income on your digital assets.

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