#Stablecoins #CBDC #USDT #USDC #SEC #BUSD
Recently, Paxos Trust Company(Paxos) confirmed reports that it had received a Wells notice from the United States Securities and Exchange Commission(SEC) due to an alleged failure to register the offering under federal securities laws, over $BUSD, which is a stablecoin issued by Paxos.
On Feb. 13, the New York Department of Financial Services (NYDFS) ordered Paxos to halt the issuance of BUSD. In Response, Paxos says it will comply, tweeting on Feb. 13 that it will halt the minting of new BUSD tokens effective Feb. 21. This isn’t the first time regulators have tightened regulations on cryptocurrency either; in fact, ever since the collapse of another, more popular stablecoin, UST, there has been a steady stream of noise about increased regulation of stablecoins to protect investors and traders.
What are stablecoins?
The price of cryptocurrencies, led by Bitcoin (BTC) and Ethererm (ETH), has been unstable. While this has provided many opportunities for speculation, it does have its drawbacks. Its volatility makes using cryptocurrency for everyday payments extremely challenging. For example, a merchant may sell a cup of coffee with $3 worth of BTC one day, only to find out the next day that its BTC value has decreased by 50%, making planning and financial operations extremely challenging.
Stablecoins are digital assets that track the value of fiat currencies or other physical assets. For example, you can buy tokens pegged to the U.S. dollar, the euro, or even gold. Before the stablecoins, investors and traders could not lock in profits or avoid price fluctuations without converting cryptocurrency back to Fiat currency. While cryptocurrency stablecoins provide a solution to both problems, by using various stablecoins, people can cope with volatility.
How many stablecoins are there?
Depending on the issuer of the stablecoins, stablecoins can be sorted into centralized ones and decentralized ones. And depending on the method of collateralization, the stablecoin types are roughly divided into three types, fiat-backed or comodity-backed stablecoins, crypto-backed stablecoins and algorithmic stablecoins.
Fiat-backed or comodity-backed Stablecoins
These two types of stablecoins are usually issued by centralized organizations. These stablecoins are backed 1:1 by fiat such as U.S. Dollars, Euros, or physical assets such as oil, real estate, gold. For each token in circulation, fiat-backed stablecoins typically have a reserve of one dollar — cash or cash equivalents. Stablecoin reserves are maintained by central entities that regularly audit their funds and work with regulators to ensure that entities holding stablecoin reserves remain compliant.
Some of the biggest stablecoins in this category include Tether(USDT), Paxos Standard(PAX), BUSD, USD Circle(USDC), Paxos Gold(PAXG), and Tether Gold(XAUT).
Crypto-backed Stablecoins
As its name implies, crypto-backed stablecoins are backed by another cryptocurrency as collateral. This process occurs on-chain by employing smart contracts instead of relying on centralized organizations to issue. When purchasing this kind of stablecoin, users lock the cryptocurrency into a smart contract to obtain tokens of equal representative value. User can then put the stablecoin back into the same smart contract to withdraw your original collateral amount.
Currently DAI is the most prominent stablecoin that makes use of this mechanism. This is realized by utilizing a collateralized debt position (CDP) through MakerDAO to secure assets as collateral on the blockchain.
Algorithmic Stablecoins
Algorithmic stablecoins are those that rely on algorithms to keep prices stable, effectively balancing funding and supply and demand on the blockchain through smart contracts. Algorithmic stablecoins act as a true central bank, defending the pegs of their currencies in the market.
If the price of an algorithmic stablecoin is pegged to $1, but the stablecoin rises higher, the algorithm automatically releases more tokens into the supply to lower the price. If it falls below $1, it will reduce the supply to bring the price back up. Some algorithmic stablecoins are known for losing their pegs during black swans or unexpected events, as market volatility rises sharply due to lack of overcollateralization. In 2022, the famous algorithimc stablecoin Terra USD, or UST lost its peg to the USD and the situation worsened due to the core mechanics, the network minted more and more LUNA tokens to save the value of the UST. This led to a decline in the value of LUNA tokens, which in turn led to an exponential increase in the volume of more minted coins. During the Luna collapse, its supply increased from 340 million tokens to 6.5 trillion. Its price went the other way.
In the end, $LUNA’s $22 billion market cap went up in smoke, wiping out the huge book gains of many retail and institutional investors.
Are stablecoins good or bad?
Stablecoins were developed to avoid the high volatility common in the cryptocurrency market. Currently stablecoins are often used as a medium for cryptocurrency investments, hedge assets, and there are more and more places that accept stable coins with stable values for payments.
However, we cannot ignore the risks of stablecoins. Lack of Regulation, possibility of depegging, and the occurrence of a run are some major risks of the stablecoins. In the past, we have seen peg failures, reserve deficits and litigation issues with stablecoins. So, while stablecoins are an extremely versatile instrument, it’s important to keep a mind that they are still a cryptocurrency and carry similar risks.
*Risk Warning
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