What exactly is happening with stablecoins and DeFi and what it means for the future of the ecosystem
A stablecoin is a cryptocurrency backed by real-world assets. FIAT-backed stablecoins such as USDT or PAXG are pegged to the US dollar and gold, respectively. By linking cryptocurrency to FIAT assets, these tokens allow for ease of use and universal access to cryptocurrency without the volatility of unbacked cryptocurrencies.
Maker token DOA, DAI, for example, is linked to the US dollar and a portion of reserve cryptocurrencies locked in a smart contract. Unsecured stablecoins like Carbon are not backed by anything. Instead, they rely on Seigniorage shares to keep the price regulated. The Seigniorage system is a calculation for regulation that keeps prices stable, relying on smart contracts to change the supply volume depending on the token price.
Stablecoins have recently come under regulatory scrutiny. Many regulators want to classify them as bonds, subject to stricter guidelines and penalties. Abra CEO explained the difference between stablecoins and bonds:
“So a stablecoin can be a security and it can’t be a security either, it depends on how you implement the stablecoin. Traditionally, banks can take deposits and invest them, and the FDIC in the United States will see what they are investing in. The question is, what can Tether do and not be considered a security? This is an open question that I think has not yet been clarified by regulators.”
In October 2021, Tether paid $41 million in fines to the Community Futures Trading Commission after being found guilty of making misleading statements about its reserves. Tether claimed that 100% of its tokens were backed by the US Dollar. An investigation by the NY Attorney General showed that not only did they not have 100% of the funds in reserve, they also had reserves in non-trust assets and unsecured products.
This is one of the potential problems with stablecoins. Many people are using stablecoins, even accepting them as payment for work delivered, for the ease of access. Fractional reserve banking has turned to cryptocurrencies, and stablecoins can cause a financial crisis if your reserves are not at 100%.
Taking the high risk
People are not complaining. They seem to understand the risk and accept it as a fair exchange for participating in the DeFi ecosystem. The cryptocurrency world has always demanded a high risk cap, and most are more comfortable with the risks associated with DeFi than the risks associated with FIAT and US hyperinflation.
Senator Elizabeth Warren recently tweeted:
“Stablecoins pose risks to consumers and our economy. They are propping up one of the darkest parts of the cryptocurrency world, DeFi, where consumers are least protected from being scammed. Our regulators need to get serious about cracking down before it’s too late.”
The best are attacked
DeFi is a serious threat to traditional financial institutions. More and more people are choosing not to be banked. Even the layman is losing faith in government money. The excessive printing of money and the Fed’s economic turmoil over the past two years have real-world implications, one of which is that the masses are turning away from financial institutions because they are reluctant to give up their money and power.