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We've learnt in the last week that stablecoins aren't all that stable.
The key stablecoin TerraUSD – also known as UST – has officially lost its peg to the US dollar, resulting in a disastrous depreciation of its companion cryptocurrency, Luna. Terra's blockchain eventually became stopped, it was delisted from most major exchanges, and the value of Luna coin dropped to zero.
Instability has already been reported in several prominent stablecoins this week, most notably DAI.
However, Ian Epstein, president of Enigma Securities, a digital broker-dealer targeting institutional wealth clients, believes that stablecoins are not a doomed concept.
Algorithmic stablecoins vs. stablecoins
"We should talk about what I consider a stablecoin vs what is just another poor notion disguised as a stablecoin," Epstein added. "Terra and some of these other coins may refer to themselves as algorithmic stablecoins, but that's actually just a fancy term for a leveraged position that claims to be the asset basis for a stablecoin."
The system collapses when the leveraged assets can no longer keep up with the stablecoin's liabilities.
It's a scenario Epstein is familiar with, having spent a decade as a macro portfolio manager at Autonomy Capital.
"We see emerging markets all the time that are pegged to the US dollar, but where the central bank's obligations do not equal the assets side of their balance sheet, their reserves," Epstein added. "This puts undue strain on the peg and causes their currency to depreciate."
When Terra's asset balance shifted too far in favor of liabilities, it triggered the digital economy's equivalent of a "run on the bank," according to Epstein. "These were Ponzi-like, poorly organized notions that reminded me of every previous unsuccessful currency peg."
According to Epstein, Terra's major mistake was employing non-dollar reserves to defend a dollar peg, while other stablecoins show more potential for true stability and lasting power.
"The USD coin (or USDC) stablecoin is a money market-like digitalization of the dollar administered by Circle," Epstein explained. "It's extremely clear — it's a true stable stablecoin that doesn't use technology to obtain anything." Circle isn't attempting to employ tractional reserve or leverage. A digital form of the dollar fulfills a utilitarian purpose; they're providing that product without being greedy. They're following the regulations as best they can. That's what a stablecoin is."
According to Epstein, Circle backs the USDC cryptocurrency with high-quality short-term paper.
Stablecoins are long-lasting
From the perspective of a broker-dealer, Epstein sees benefit in a stablecoin operating as a transparent, fully backed digitized money market fund. "It has excellent transparency and ease of use, and it gives significant value, as will other true stablecoins comparable to USDC that will emerge in other currencies over the next six to twelve months."
Epstein's institutional clients are likewise paying careful attention to the stablecoin market. Stablecoin balance sheets should improve when interest rates and yields rise.
Despite the unfavorable press surrounding stablecoins, Epstein believes that the motive to develop a true stablecoin as a regulated and transparent institution persists.
Others, such as AdvisorBId creator Brandon Spotswood, believe that the failure of Terra and other stablecoins would result in tighter regulation and may prompt central banks to speed work on their own digital currencies.
Another topic of interest is DeFi
It may be difficult to comprehend institutional interest in decentralized finance (DeFi), technology designed to disintermediate the financial transactions that have produced many of the world's financial institutions, but Epstein believes it exists.
Institutions are drawn to DeFi because of the efficiencies generated by smart contracts, which allow for a trustless exchange with no third-party middlemen, ensuring asset exchange and immediate settlement of transactions at any moment.
"Think about all the economic rents that enterprises engaged in that sort of activity obtain, and it was a really essential activity, building trust bridges," Epstein said. "Smart contracts now accomplish that automatically for us." Consider how long it takes to settle a transaction and how much of the year the market is open. Everything now settles instantly, markets may operate 365 days a year, and decentralized finance makes it all feasible. That has significant value, and it has nothing to do with algorithmic stablecoins."
Institutions are still making tiny steps
Along with the startling collapse of Terra and Luna, the crypto market has seen unpredictable price swings, which may play into the hands of sophisticated investors such as hedge funds, asset managers, and other institutions served by Enigma.
According to Epstein, these investors are still ramping up their crypto operations and developing investment mandates, and the majority of them incurred minor losses in the recent downturn since they have yet to put the majority of their capital to work.
"For significant institutions, digital assets are no more affected than they are right now in fixed income, where credit markets have had a terrible run, or in technology, which is also down a bit, or in emerging markets, which are also down," Epstein added. "There are some fears that the earlier pricing and appraisals they were considering would be difficult to justify." In some ways, a repricing of these markets is to their advantage because they are further along in their accumulation of human intellectual and financial resources to put to work in this arena."
Financial capital moves swiftly, especially in volatile markets, as it seeks safety and value, according to Epstein. Human capital is more likely to provide the entire picture.
"I've never seen so much human capital aggregated into one space before – financial capital always goes into all kinds of things, markets go up and down – but human capital, sheer geniuses moving into a space and thinking about ways to leverage the technology, that is the most important sociocultural phenomenon in digital assets," Epstein said. "As a result, institutional interest and adoption will not wane." The value of bitcoin is less important."
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