Terra: How stablecoins fared in the crypto bear phase!

Most cryptocurrencies have significantly underperformed the leading stock market indices due to liquidity pressures caused by monetary policy tightening by leading central banks such as the US Federal Reserve.

Quantitative tightening aimed at reining in record inflation numbers in the world’s largest economy has seen both stock and cryptocurrency prices correct sharply from their highs, eerily reminiscent of the bear cycle of 2017.

Are stablecoins really stable?

While stablecoins may suffer tether (CRYPTO:USDT) and USD coins (CRYPTO:USDC) rose after the decoupling from the US dollar, the collapse of Earth (CRYPTO: UST) shattered faith in stablecoins after wiping out billions of dollars in investor capital.

Although USDT and USDC account for nearly 80% of the stablecoin market, the panic triggered by the UST crash has caused USDT to lose more than $10 billion in market cap, while USDC has benefited greatly, and its market share in the aftermath is increased from 27% to 34%.

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These tokens, issued on a 1:1 basis with collateralized US dollar funding, have now stabilized near the $1 mark as their issuers have taken steps to secure additional collateral to offset additional pressure to sell from undecided investors.

Overcollateralized stablecoins vulnerable to liquidity risk

On the other hand, overcollateralized stablecoins are like come on (CRYPTO:DAI), Magic internet money (CRYPTO:MIM) and Liquidity USD (CRYPTO:LUSD), the non-stablecoin cryptocurrencies like Bitcoin (CRYPTO: BTC) and Ethereum (CRYPTO:ETH) as collateral remains vulnerable to liquidity risk created by falling prices of these leading cryptocurrencies.

Since these over-collateralized stablecoins use BTC, ETH or other derivative assets as collateral, the extra margin required to maintain the peg to the US dollar tends to put further downward pressure on the underlying cryptocurrency. This can ultimately have a domino effect, as the UST crash impressively demonstrated.

While the exact mechanism of the UST crash is a bit more complex, it is clear that stablecoins still have a long way to go before they can regain investor confidence.

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Some stablecoins like USDD (CRYPTO: USDD), issued by Tron and whose primary operations are managed by the TRON DAO Reserve, has shown better stability and offers investors who support the stablecoin an interest rate of 30%.

However, a large part of this strength is the fact that retail investors can only trade USDD stablecoin on the secondary market, while all other activities such as issuing, burning and token management are subject to the approved whitelist of TRON DAO Reserve and not the assigned underlying algorithm.

Innovative ways to maintain USD peg

Another approach is this FRAX Stablecoin touted by its creators as the world’s first fractional-algorithmic stablecoin. He uses USDC as collateral and Frax share (CRYPTO:FXS) as a value accretion and governance token that remains volatile by design.

Frax offers better stability than fully algorithmic stablecoins like UST or TerraClassicUSD (CRYPTO: USTC). FRAX is an example of crypto entrepreneurs experimenting with innovative ways to keep the US dollar pegged with more stability.

Stablecoins are fueling the DeFi expansion

Although the choice is often made based on profitability due to incredible interest rates, stablecoins are increasingly fueling the expansion of decentralized finance (DeFi) and will continue to attract more protocols vying to fill the void left by UST – the crash advantage.

While it remains to be seen how the entire basket of stablecoins will navigate the current crypto bear market, further price corrections could seriously undermine the foundation upon which these virtual assets were created.

Governments consider regulation

Recognizing the need for immediate regulation to avoid a repeat of the UST debacle, financial regulators in the US and UK markets are already considering legislative changes to ensure that the existing regulatory framework mitigates the risks associated with the failure of such firms, like Spend stablecoins, contains them.

Whether issuers will need to hedge their stablecoins with real assets in the future rather than with other stablecoins or cryptocurrencies is still a matter of speculation. Both innovation and regulation will be required to ensure that stablecoins can stand the test of time and survive in a Web3-dependent world.

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