Stablecoins Play a Crucial Role in DeFi Protocols, Providing a Trustworthy Medium of Exchange Between Crypto Tokens – Report

Stablecoins, digital currencies pegged to major fiat currencies, have recently been the subject of a detailed report by S&P Global. The aim of stablecoins is to provide a link between the volatile cryptocurrency markets and the traditional financial sector.

The report highlights that while stablecoins strive to maintain a pegged value, the stability of each stablecoin varies significantly based on the collateral it is backed by, or the lack thereof.

The report warns that stablecoins are not without risk and are subject to market volatility, as well as market confidence and adoption. The technology stack on which stablecoins are built, along with demand, supply, and market liquidity, also play a role in their stability.

One of the main risks identified in the report is the deviation from the pegged value. The report examines five stablecoins and finds that incidents where the value drops below $1 occur frequently and can last longer than those where the value rises above $1.

Interestingly, the report notes that weekends almost halve the volatility of some stablecoins, possibly due to their dependence on traditional payment channels that operate strictly during regular banking hours. Transparency in stabilization mechanisms and redemption routes also influences market prices, according to the report.

The report emphasizes that blockchain technology offers 24/7, borderless, and fast payment capabilities but requires the use of programmable digital tokens. On the other hand, cryptocurrencies like bitcoin and ether are highly volatile and impractical for many financial applications due to their lack of underlying stabilization mechanisms.

Stablecoins play a crucial role in decentralized finance (DeFi) protocols, acting as a medium of exchange between other cryptocurrencies. They provide users with the ability to borrow against other crypto assets, hedge against a long position, create a short position, or take out a personal loan using an asset with stability comparable to a strong fiat currency.

The report also discusses the depegging incidents of two stablecoins, USDC and DAI, following the failure of three US banks. USDC dropped by 13% below $1 after Circle, its issuer, confirmed that $3.3 billion of cash reserves were held at one of the failed banks. Circle and Coinbase temporarily paused conversions between USDC and fiat US dollars.

DAI’s value closely tracked that of USDC due to the substantial collateral reserves backed by USDC. However, both stablecoins recovered to their peg levels with the support of the Federal Reserve and subsequently adjusted their reserve compositions. USDC’s cash reserves are primarily held at the Bank of New York Mellon, while DAI diversified its reserves across multiple stablecoins and increased the share of real-world assets.

It is important to note that not all stablecoins were affected in the same way. Tether, for example, had no exposure to the failed banks and saw a slight increase in value above $1 as market participants shifted away from the affected stablecoins before returning to parity.

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