Unstable Stablecoins: The Cryptocurrency Paradox | The Motley Fool

Stablecoins are digital currencies designed to hold a stable value against a benchmark asset, such as the US dollar. However, a series of bank liquidations in and around the cryptocurrency market is shaking up these supposed models of security and stability.

Can these supposed models of long-term digital stability be trusted? Let's think about it.

What is happening?

He sudden liquidations of Silvergate Capital (AND -5.56%), Silicon Valley Bank (BLIMS -60.41%)and signature bank (sbny -22.87%) it sent immediate ripples through the cryptocurrency market. Dollar-based stablecoins are taking this crisis on the chin, moving far away from their intended price of $1 per token.

stablecoins they are intended as a reliable and predictable alternative to other cryptocurrencies, which are often notorious for their volatility. But recent events have shown that even stablecoins are not immune to market forces. The price of USD currency (USDC 0.06%) it fell as low as $0.88 in the early morning hours of Saturday, March 11. industry leader Tie (USDT -0.23%) it briefly rose to $1.02 last Thursday.

These moves may not sound like much, but they are massive system shocks in the context of the long-term strength of a stablecoin. The weekend chart doodles are pretty cheeky, to misquote punk rock legend Glen Matlock:

belt price data by YGraphics.

Stablecoins regained their footing on Monday morning, trading at less than 1% from their ideal value of $1, as their backing organizations found ways around collapsing banks. Still, the bank liquidations that triggered the liquidity crisis have sown the seeds of uncertainty and anxiety, casting a shadow over the stability of the stablecoins.

USD Currency: Unfortunate Banking Connections

USD Coin recorded some of the biggest price drops in this crisis due to its close connections with some of the banks in liquidation.

Circle Internet Financial, which manages this stablecoin in partnership with the cryptocurrency trading platform giant coin base (CURRENCY 10.72%), owned $3.3 billion of USD Coin cash backing at Silicon Valley Bank. When the California Department of Financial Innovation and Protection closed that bank, nearly 8% of USD Coin's cash reserves appeared to be locked in the vaults of a collapsing bank and perhaps lost forever. Additionally, Circle held cash at Silvergate and Signature Bank in January, increasing cash risk.

That is why the USD Coin price chart fell 12% lower as the banking crisis unfolded. With much of the stablecoin's cash reserves parked in potentially unreachable bank accounts, investors worried that the stablecoin could be the target of some kind of digital run on the banks. If most USD Coin holders wanted to cash out their holdings overnight and Circle couldn't access some of their backing cash, it would be a disaster much like what happened to the banks in liquidation in the first place.

The risk quickly faded when the Federal Reserve promised to provide funds to account holders at the banks in question. As a result, Circle is free to move its cash from Silicon Valley Bank and other trouble spots to more robust financial institutions. Circle's Tether reserves are now held primarily with black rock (BLACK -1.46%) and Bank of New York Mellon (B.K. -6.74%)two highly respected investment banks.

So USD Coin went back to exactly $1 on Monday morning as the stablecoin dodged a bank bullet.

Tether: a safe harbor in the storm

Tether showed the other side of the same coin. The largest stablecoin, under the management of the iFinex group that also runs the popular Bitfinex cryptocurrency exchange, posted unusual gains in this banking crisis.

This group keeps its banking relationships to the letter, but it seems unlikely that Tether has cash accounts with Silvergate, Signature Bank, or Silicon Valley Bank. Despite its best efforts to keep the details under wraps, Tether is known to prefer banks in the Bahamas. His Treasuries are reportedly being held by financial giant Cantor Fitzgerald on US soil, taking the usual crypto suspects out of the equation.

Thus, Tether saw a surge in investor interest when USD Coin was badly captured, and its token price rose above its expected value of $1. A yield greater than 2% is a big problem when the graph can normally be drawn with a ruler and no adjustment.

Navigating Stablecoin Challenges: Tighter Regulation and Better Banking

Stablecoins help crypto exchanges facilitate transactions and provide liquidity in the crypto markets. If stablecoins cannot live up to their unwavering name, the resulting instability would disrupt cryptocurrency growth and adoption. But there are some reasonable ways to address these challenges.

One way out is to improve the regulatory framework around cryptocurrencies in general and stablecoins in particular. By increase regulatory oversight and reporting transparency, stablecoins can improve your stability and reliability.

Another solution is to diversify the cash reserves that back the stablecoins. As the cryptocurrency market evolves, stablecoins should have better access to the big, strong banks that used to shrug off digital assets. By holding cash at multiple high-quality banks and financial institutions, stablecoin issuers can mitigate the risk of bank failures and enhance the resilience of stablecoins.

In general, recent events have highlighted the need for greater transparency, regulation, and risk management in the stablecoin market. But despite these challenges, stablecoins backed by strong cash assets still seem like useful and valuable tools in a growing crypto market.

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