Was the ICT disaster Terra the Canary in the algorithmic stablecoin coal mine?

Was the ICT disaster Terra the Canary in the algorithmic stablecoin coal mine? – Mail Bonus

Last week has not been easy. Following the collapse of the third largest stablecoin (UST) and what was previously the second largest blockchain after Ethereum (Terra), the depeg infection appears to be spreading.

While UST completely got rid of the US dollar and traded below $ 0.1 at the time of writing, other stablecoins also experienced a short period in which they also lost their dollar connection due to market turmoil.

Tether’s USDT stablecoin saw a brief devaluation from $ 1 to $ 0.95 at its lowest point in May. 12.

USDT / USD last week from May. 8–14. Source: CoinMarketCap

FRAX and FEI had a similar drop to $ 0.97 on May 12; while Abracadabra Money’s MIM and Liquity’s LUSD fell to $ 0.98.

FRAX, MIM, FEI and LUSD prices from May. 9 – 15. Source: CoinMarketCap

Although it is common for stablecoins to fluctuate in a very narrow range around the $ 1 connection, these recent trades are only visible in very stressful market conditions. The question now sitting in investors’ minds is will the fear spread even further and will another stablecoin be disconnected?

Let’s take a look at the dynamics of some of the major stablecoins and how they are traded in the Curve Finance liquidity pot.

The main purpose of stablecoins is to preserve constant value and provide investors with a way to invest their money when fluctuations from other cryptocurrencies are much greater.

There are two separate methods in stablecoins – asset secured and algorithm based. Property-secured stablecoins are the most common version and issuers pretend to support stablecoins in fiat currency or other cryptocurrencies. Stablecoins based on algorithms, however, seek to use algorithms to increase or decrease the supply of stablecoins based on market demand.

Property-secured stablecoins were in favor of a downturn, except for the USDT

USD Coin (USDC), Dai (DAI) and USDT are the most traded asset-backed stablecoins. Although they are all over-pledged by fiat reserves and cryptocurrencies, USDC and USDT are centralized while DAI is decentralized.

The USDC Guarantee Funds are held by US financial institutions, while the USDT Reserve Funds are held by Tether Limited, which is controlled by BitFinex. DAI, on the other hand, does not use a centralized unit but uses primary market borrowing rates to maintain its dollar link, known as the Target Rate Feedback Mechanism (TRFM).

DAI is entered when users take out a loan against their collateral and deleted when the loan is repaid. If the DAI price is below $ 1, then TRFM raises the borrowing rate to reduce the DAI supply as fewer people want to borrow, with the aim of raising the price of the DAI back to $ 1 (as opposed to the DAI above $ 1).

Although the DAI connection system seems to be an algorithm, overinsurance makes it at least 150% a powerful asset-backed stablecoin in volatile market conditions. This can be seen by comparing the price changes of the USDC, USDT and DAI over the past week as the DAI, along with the USDC, clearly showed an increase on May 12 when investors lost confidence in the USDT and rushed to replace.

USDT, USDC and DAI hourly rates. Source: CoinGecko API

Tether’s USDT has long been controversial despite its large market share in the stablecoin space. It was previously fined by the US government for incorrectly disclosing what kind of cash they have. Tether claims to have cash or equivalent assets to support the USDT. However, a large part of the reserves turns out to be commercial paper – a type of unsecured short-term debt that is more risky and is not the “cash equivalent” as the US government prescribes.

Recent Terra problems and the lack of transparency in their reserves raised new concerns about the USDT. The price reacted harshly with a short devaluation from $ 1 to $ 0.95. Although USDT prices have recovered to close at $ 1, concerns remain.

This is clearly seen in Curve Finance’s largest liquidity pool. DAI / USDC / USDT 3pool in Curve shows a ratio of 13% -13% -74% for each of them respectively.

Curve DAI / USDC / USDT 3Pool ratio. Source: @elenahoo Dune Analytics

Under normal circumstances, all assets in a stablecoin liquidity fund should be of equal (or very close equal) weight because all three stablecoins should be valued at around $ 1. But what the pools have shown over the past week is an imbalance, as the USDT maintains a much higher rate. This indicates that the demand for USDT is much lower than the other two. It could also mean that for USDT to maintain the same dollar value as the other two, more units of USDT are needed in the pool, indicating lower values ​​for USDT compared to DAI and USDC.

A similar imbalance is seen in the DAI / USDC / USDT / sUSD 4 pool. It is interesting to see that sUSD and USDT both rose in proportion around May 12 at the peak of stablecoin fears. But the sUSD has quickly returned to an equal share of 25% and has even fallen in percentage points since then while the USDT remains the highest percentage in the pool.

Curve DAI / USDC / USDT / sUSD 4Pool ratio. Source: @elenahoo Dune Analytics

Curve 3pool has a daily trading volume of $ 395 million and a total value of $ 1.4 billion blocked (TVL). 4pool has a $ 17 million trading volume and a $ 65 million TVL. Both pools show that the USDT is even less favorable.

Are algorithmic stablecoins created?

The stablecoin algorithm is a different system from the fixed stablecoin. It has no reserve fund; therefore, it is unencumbered. Peginu is maintained with a currency algorithm and burning stablecoin and its partner currency based on supply and demand in the market distribution.

Because of its non-collateral, or less than 100% collateral nature, algorithmic stablecoin is far more risky than asset-backed stablecoin. The Terra UST depeg dilemma has certainly shaken investor confidence in the stablecoins algorithm. This has been made quite clear in the Curve liquidity pot.

FRAX – the stablecoin algorithm with Frax Protocol – is partly supported by collateral and partly based on supply and demand algorithms. Although the currency is partly guaranteed, the ratio of mortgage and algorithm still depends on the market price of FRAX.

In the recent perfect storm of stablecoin horrors, the rate of FRAX against the other three stablecoins rose to 63% to 37%. Although the excess is already visible from the beginning of March 2022, the collapse of UST certainly increased the fear of FRAX disconnection.

Curve FRAX / 3CRV 3Pool ratio. Source: @elenahoo Dune Analytics

A similar increase in fear caused by the Terra UST de-peg event is also present in MIM – Abracadabra Money’s algorithmic stablecoin. The Curve MIM / 3CRV pool shows that the MIM ratio jumped to 90% – a similar level was reached in January when the Wonderland scandal broke out.

Curve MIM / 3CRV 3Pool ratio. Source: @elenahoo Dune Analytics

Despite an algorithm similar to DAI, MIM does not use ETH directly as collateral but uses interest-bearing tokens (ibTKN) from Yearn Finance – ywWETH. The additional layer of complexity makes it more vulnerable to catastrophic events such as the ICT depeg event.

The goal of all stablecoins is to maintain a stable value. But everyone is experiencing fluctuations and many of them have deviated from the $ 1 connection much more than expected. This is probably why it has led some regulators to claim that stablecoins are neither stable nor currency.

Nevertheless, fluctuations in stablecoin are much smaller than some of the other cryptocurrencies and still provide a safe haven for cryptocurrencies. It is therefore important to understand the risks involved in connecting different stablecoins.

Many stablecoins have failed in the past, ICT is not the first and certainly will not be the last. Keeping an eye on not only the dollar value of these stablecoins but also how they stand in the liquidity pot will help investors identify the potential risks ahead in a bearish and volatile market.

The views and opinions expressed herein are those of the authors only and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading business involves risk, you should conduct your own research when making a decision.