Blockchain for Banking News

Federal Reserve financial stability report cites stablecoin run risks as TerraUSD loses peg

us federal reserve

Yesterday the U.S. Federal Reserve published its semi-annual Financial Stability Report, in which stablecoins, central bank digital currencies, and cryptocurrencies all received a mention. In particular, the report highlights the run risk of stablecoins.

It cites several related risk factors, including the rapid growth of stablecoins to a market capitalization of $180 billion with a few large issuers. During times of stress, the backing assets might become illiquid, making the stablecoins hard to redeem. Plus, stablecoins used for cryptocurrency margin requirements could exaggerate the risks.

In contrast, when the Fed conducted a survey of financial stability concerns, it found that compared to six months ago, worries about several topics, including cryptocurrency and stablecoin risks, have declined. Crypto and stablecoin risks dropped from fifth biggest concern down to twelfth spot.

Concerns have previously been expressed about the quality of the assets that back the collateralized Tether stablecoin. The Fed has primarily focused on fully collateralized fiat-backed stablecoins, as opposed to algorithmic stablecoins. 

An algorithmic stablecoin loses its peg

Not mentioned in the report is that in late April Terra USD (UST), an algorithmic stablecoin became the third largest stablecoin overall, with a market capitalization of more than $18 billion. Yesterday during the cryptocurrency market volatility, the UST stablecoin de-pegged to just 60 cents on the dollar. It has since recovered to above 90 cents. 

Rather than using collateral, algorithmic stablecoins use arbitrage to maintain a peg. In the case of UST, it works by burning the Luna cryptocurrency to create UST, or vice versa, burning UST to create Luna. 

In recent months a treasury – the Luna Foundation Guard – that includes Bitcoin and other crypto was created to be able to step in during market volatility, as happened yesterday. $1.5 billion was lent to market makers to protect the UST peg. The Luna token price is down 46% in the last 24 hours and by two-thirds in the previous two weeks.

Some have described UST as a Ponzi scheme because the Anchor protocol offers up to 19.5% APR on UST deposits, which is not viewed as sustainable. The value of UST stablecoin locked in the Anchor protocol has accounted for half the market capitalization of UST, although it’s a little less at the moment. In February, Anchor received $450 million from the Luna Foundation Guard to support this high return.

Image Copyright: maxxyustas / 123rf