A stablecoin can be divided into two categories – collateralised and non-collateralised stablecoins. Collateralised stablecoins are virtual assets which price is pegged to a reference asset, for instance a fiat currency, a commodity, or even other virtual assets. Non-Collateralised stablecoins maintain their price by adjusting the demand and supply by an automated algorithm. To have a better understanding of what Stablecoins are, please click here.
When Stablecoins are not stable
There have been multiple drivers of stablecoin de-pegs in recent years. Major factors included lack of regulation, governance and risk management issues at a large crypto exchange, stress within traditional finance, and imbalances in digital asset pools that supply liquidity to decentralized exchanges.
Collateralised Stablecoins
In contrast to central bank digital currencies (CBDCs), which are digital versions of fiat (government-backed) currencies, stablecoins are run by private entities, which often there is a lack of transparency around the underlying reserves being held. Stablecoins have lost their pegs to reference assets on multiple occasions, driven by market events such as the FTX crash, regulatory enforcement actions, insufficient reserves held, security breaches on DeFi protocols, as well as attacks on stablecoin liquidity pools.
Non-Collateralised Stablecoins
This model maintains stability by adjusting the coin supply. When the price exceeds the desired level, more coins are mined and auctioned to lower the price. Conversely, if the price falls below the desired level, the system buys coins to raise it. When reserve funds are insufficient for purchases, seigniorage shares are issued, granting future profit rights. Basis extended this model to address seigniorage’s vulnerability to death spirals, where share prices rely on seigniorage coin demand recovery. Without demand recovery, issuing shares could lead to system collapse. An example is the collapse of Terra UST, a non-collateralized stablecoin.
Historical events of Stablecoin Failures
Terra UST Collapse (May 2022): Terra’s UST collapse illustrated the dangers of unregulated stablecoins, causing a significant market value loss and impacting Tether’s USDT value temporarily.
FTX Bankruptcy (November 2022): FTX’s bankruptcy led to the de-pegging of USDT, raising concerns about industry contagion and causing a ripple effect on other digital asset platforms.
USDC De-pegging (March 2023): USDC’s loss of peg below $0.90 due to exposure to Silicon Valley Bank highlighted the risks of traditional and decentralized finance interconnection, affecting other stablecoins like BUSD and DAI.
Liquidity Pool Imbalance (June 2023): Unbalanced liquidity pools on platforms such as Curve Finance and Uniswap caused stablecoin de-pegging, showcasing vulnerabilities to market manipulations and the influence of large market participants on stablecoin markets.
Regulatory Development in Hong Kong
The lack of clear regulations poses a major challenge to investor trust, impacting the broader acceptance of stablecoins. Given the increasing links between traditional finance and virtual assets, the HKMA is developing regulations for stablecoin issuers in Hong Kong. To prepare for implementing these regulations, the HKMA has initiated a sandbox program in March 2024 to foster discussions between the authority and the industry regarding the proposed regulatory standards1.
Following on from the joint consultation by the Financial Services and the Treasury Bureau and the HKMA in July 2024, the Hong Kong government has published the Stablecoins Bill (the “Bill”) which had its first legislative reading on 18 December 20242.
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