Stablecoins at 10: From right place, wrong time, to right place, right time

Examining Previous Failures

The idea of stablecoins was first introduced in 2014 with the launch of BitUSD, the world’s first stablecoin. Despite its promise of offering a stable digital currency, BitUSD lost its one-to-one parity with the US dollar and has been unable to recover since. The early years of stablecoins were marked by numerous failures, primarily due to poorly thought-out mechanisms, lack of robust infrastructure, and regulatory oversight.

One notable example is TerraUSD (UST), which maintained its price peg through an arbitrage mechanism involving its sister token, LUNA. However, this mechanism had several flaws. During normal conditions, the redemption fee was 0.5%, but during the collapse, fees skyrocketed to 60%, making it unprofitable for arbitrageurs to restore the peg. Inaccuracies in the Luna Price Oracle contributed to instability, with discrepancies up to 70% between the Oracle Price and exchange price.

Other stablecoins, like Acala USD (aUSD), and DEI from Deus Finance, also faced significant issues. Acala USD, for example, was brought down by a technical exploit where hackers were able to mint 1.28 billion aUSD due to a misconfiguration in a liquidity pool. DEI was targeted in a hack that exploited vulnerabilities on multiple networks, leading to a $6 million loss.

Learning From the Past

Today, the environment for stablecoins has vastly improved. Learning from the mistakes of the past, modern projects reflect more robust models and well-considered mechanisms. For instance, we have seen less non-collateralised, algorithmic stablecoin projects enter the market in favor of fiat and commodity-based stablecoins. Unlike algorithmic stablecoins, collateralised stablecoins do not rely on market forces to maintain their stability and are less exposed to fundamental risk.

Modern stablecoins are also built on more secure and scalable blockchain platforms, reducing the risk of technical exploits. Factors include better standards, as well as the fact that the sector’s professionalization has attracted top talent from major technology companies, cybersecurity fields, and more.

Regulatory Certainty

In the early days of stablecoins, the regulatory landscape was characterized by a lack of clear guidelines and standards. This ambiguity posed significant challenges for stablecoin projects, as they navigated a complex web of financial regulations across different jurisdictions. However, today, regulatory bodies are successively introducing clearer guidelines that help to mitigate risk, introduce good governance, and provide much-needed certainty for projects to thrive.

The Hong Kong Monetary Authority is expected to introduce its stablecoin regime in the coming months. The licensing criteria and conditions are expected to include stringent requirements to ensure the stability and integrity of stablecoins under its jurisdiction. The city is known for having developed some of the highest standards in financial regulation and governance through its rise as an international financial hub.

Dubai’s VARA regime also offers an attractive foundation for digital asset companies to build businesses and solutions in the market. Only recently, the Central Bank of the United Arab Emirates approved the issuance of regulations for licensing and oversight of stablecoin arrangements. The European Commission’s MiCA regulation also includes provisions addressing capital requirements, governance, and consumer protection for stablecoins.

Interoperability and Exchangeability

Regulation will play an important drive since regulated stablecoins will have the same KYC and AML mechanisms as Central Bank Digital Currencies (CBDCs), creating a level playing field. Exchangeability and interoperability between the two will open up the utility of stablecoins to traditional financial services.

Today, the usage of stablecoins remains largely focused on cross-border payments and remittance scenarios. Proliferation and broadening the scope of its utility must be predicated by greater credibility and trust. Historic issues with well-known stablecoins and heavy exposure to the U.S. market at a time of inherent uncertainty continue to shadow the sector.

Conclusion

In conclusion, stablecoins have come a long way since their inception. The early failures provided valuable lessons that have shaped the development of more resilient and reliable stablecoins. As the world continues to change, as risk and uncertainties grow, there has never been a stronger desire from people and businesses for greater trust, certainty, and consistency. Therefore, stablecoins are in the right place at the right time, supported by robust infrastructure, emerging regulatory frameworks, and increased interoperability.

FAQs

Q: What are stablecoins?

A: Stablecoins are digital currencies that are pegged to the value of a traditional fiat currency, such as the US dollar, and are designed to maintain a stable value.

Q: What are the benefits of stablecoins?

A: Stablecoins offer a more stable and reliable form of digital currency, making them more attractive for cross-border payments, remittances, and other financial transactions.

Q: What are the challenges facing stablecoins?

A: Stablecoins face challenges such as regulatory uncertainty, lack of interoperability, and limited adoption. However, regulatory bodies are introducing clearer guidelines, and interoperability is improving, making it easier for stablecoins to thrive.

Q: How do stablecoins work?

A: Stablecoins work by pegging their value to a traditional fiat currency, such as the US dollar, and are collateralized by assets such as cash and cash equivalents. This ensures that the value of the stablecoin remains stable and does not fluctuate like other digital currencies.

Q: What is the future of stablecoins?

A: The future of stablecoins looks promising, with emerging regulatory frameworks, increased interoperability, and improving credibility and trust. As the world becomes increasingly digital, stablecoins are likely to play a transformative role in the financial system.