Stablecoins Now Serve A Key Role in DeFi Protocols, Acting as a Reliable Medium of Exchange Between Crypto Tokens – Report

Stablecoins are digital currencies which are pegged to major (and relatively stable) fiat currencies like the US dollar, Euro, the British pound (among others).

Recently, the team at S&P Global provided a deep dive report into valuation and depegging of stablecoins. As explained in the report, stablecoins aim to offer a bridge between the highly volatile cryptocurrency markets and the traditional financial sector.

As stated in the comprehensive report, stablecoins aim to maintain a pegged value, however, the stability of each stablecoin significantly differs based on the kind of collateral it is backed with, or lack thereof.

As clarified in the update, stablecoins are not risk-free and may be subject to market volatility, and even market confidence and adoption (much like other assets). Stablecoins are also dependent on the technology stack they’re developed on and the associated risks, along with the demand and supply / market liquidity.

As stated in the report, deviation from the pegged value is considered to be one of the most critical risks for stablecoins. For the five stablecoins examined in the extensive report, depeg incidents where the value drops below the $1 mark seem to be quite frequent and can last longer than those where their value rises above the $1 mark.

For a few of these stablecoins, with the exception of weekends almost halves their volatility.

This could be related to the fact that they depend on traditional payment channels which operate strictly during regular banking hours. As explained in the report, the level of transparency “on stabilization mechanisms and redemption routes influences market prices.”

The report issued by S&P Global with contributions by S&P Global Ratings further noted that Blockchain technology “promises 24/7, borderless and fast payment capabilities, but transactions require the use of programmable digital tokens.”

The report also mentioned that cryptocurrencies such as bitcoin and ether are speculative assets “with no underlying stabilization mechanism, meaning they are highly volatile and impractical for use in many financial applications.”

The report added:

“Stablecoins address the need for digital tokens that maintain a consistent value relative to a reference asset such as fiat currency (for example, US dollar). Stablecoins play an essential role in decentralized finance (DeFi) protocols, acting as a medium of exchange between other cryptocurrencies. They allow users to borrow against other crypto-assets, to hedge against a long position, to create a short position or to take out a personal loan with an asset with stability closer to a strong fiat currency.”

As noted in the report, the failure of three US banks — Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank — “caused both USDC and DAI to depeg.”

The report added that USDC depegged “by 13% below $1 after its issuer, Circle, confirmed that $3.3 billion of cash reserves backing USDC were held at SVB.” Circle and partner Coinbase paused conversions “between USDC and fiat US dollars.”

The report also noted that DAI’s value closely “tracked that of USDC because at the time USDC holdings and related instruments represented over half of the collateral reserves backing DAI.”

Both stablecoins recovered to their peg levels “after the Federal Reserve confirmed that it would support the banks’ creditors.”

The report also stated that both stablecoins also “subsequently adjusted the composition of their reserves.” The cash portion of USDC’s reserves “is primarily held at Bank of New York Mellon, which is also the primary custodian for the reserve assets for USDC.”

DAI’s reserves diversified away “from USDC across multiple stablecoins and significantly increased the share of real-world assets.”

The report clarified that not all stablecoins “were affected in the same way.”

Tether, for example, had “no exposure to SVB; its value increased slightly above $1 as market participants rotated out of the affected stablecoins, before returning to parity.”

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