a history of failed stablecoins

By Ryan S. Gladwin 3 minutes Read

The idea behind stablecoins is that, unlike other forms of cryptocurrency that often have wildly fluctuating prices, a stablecoin is pegged to a sturdier asset, usually the US dollar. It is designed to provide the benefits of paying with cryptocurrency without the wild price swings. Or at least, that’s how it should work.

The problem occurs when the price deviates significantly from the clutch. Investors panic, there is essentially a run in the bank and the coin falls into a “death spiral”, that’s what happened to Terra USD (UST).

There are three main types of stablecoins: fiat-backed (where the token holds equal reserves of the currency it is pegged to); crypto-backed (where the token is backed by cryptocurrencies); and algorithmic (where the token relies on algorithms to regulate supply and demand to tie the price to a dollar).

UST is a mix of crypto-backed and algorithmic (not all algorithmic stablecoins are backed by an asset). Historically, most of the stablecoins we’ve seen fail have been algorithmic.

Stablecoins that weren’t

The most infamous example of a failed stablecoin was Basis Cash, which launched in late 2020 and quickly burned out. At its peak, Basis Cash had a market cap of $30.74 million. Basis Cash struggled to hold onto its peg, falling from $1 to $0.30 in the month of January 2021.

The project used a so-called ‘seigniorage algorithm’. In this system, two (or more) tokens are created: one is the stablecoin and the other is a token that can be freely moved like any other token. When the price of the stablecoin falls below $1, holders of the second token can purchase the stablecoin at a discounted price. This pushes the price back to $1. In the event that it moves above $1, more of the stablecoin is created and spread across the network, pushing the price back down.

This is a similar system that Terraform Labs has adopted with its LUNA and UST tokens. (CoinDesk recently reported that Terraform Labs founder Do Kwon, one of the the pseudonymous founders of Basis Cash

Another major seigniorage algorithmic stablecoin to fail was Empty Set Dollar, which also launched in late 2020 and peaked at a market cap of $22.74 million. Within months, the token lost its peg to the US dollar and began to fall below $0.01.

Then there was the death of Iron Finance‘s stablecoin in June 2021, which wiped out investor holdings, including Mark Cuban, who quickly asked for regulation in space. That stablecoin used a partially crypto-collateralized seigniorage algorithm, similar to the one Terra adopted with UST. When Iron’s TITAN token became overvalued, many major investors sold off, the stablecoin was decoupled from the US dollar, and – you guessed it – another death spiral.

While these are the biggest stable coins to fail, many others fell over before they could do any major damage. Other stablecoin projects that broke down and never recovered include SafeCoin, BitUSD, DigitalDollar, NuBits, and CK USD.

Can UST come back?

Things look extremely bleak for Terra. There has been at least one stablecoin to recover from a deadly spiral, but the situation was different.

stablecoin OUSD has been hacked in November 2020, leading the price to plummet to $0.14. The price did not move for months, making investors sweat. It was able to successfully relaunch in January 2021, has stayed close to $1, and has increased its market cap to just over $60 million, from less than $1 million before the hack.

In any case, the fall of Terra and the ensuing crypto crash have sparked calls for more regulation of the industry. It has also raised new concerns about Tether, the largest stablecoin, which briefly lost its peg to the US dollar in the wake of the collapse of UST. Tether claims to be a fiat-backed stablecoin, backed by cash or “cash equivalents.” However, Tether has previously been fined by the US government for allegedly misrepresenting his reserves and has since not been so transparent about his reserves, as many would like.

After the fall of UST, US Treasury Secretary Janet Yellen said she hopes Congress can pass legislation to… a regulatory framework for stablecoins sometime this year.