TOP STABLECOINS, Compliance and Security.
Are stablecoins really stable? An in-depth case study based on the third-biggest stablecoin in the world BUSD and a dive into Solana ecosystem stablecoin USDH’s lessons from MakerDAO and LIQUITY.
“The fact that stablecoins are pegged to a “real” asset does not equate to stability. Traditional underlying assets are not exempt from market fluctuations, and with the majority of stablecoins pegged to fiat, they can be just as unstable.”
USE CASE
Stablecoins have emerged as significant players in the crypto market this year, driven by user demand for flexible liquidity in fiat currency times. These currencies are defined as a type of digital currency that can be pegged to underlying real-world assets or backed by them. These assets can be anything from fiat money, commodities like gold or silver, or even another cryptocurrency. As their name suggests, stablecoins are designed to have a value that stays (rather) stable like cash, a contrast to the volatility common in cryptocurrency trading today.
To further illustrate this scenario, a typical fiat-backed stablecoin might involve the token issuer holding 100,000 tokens, each worth $1 USD. Token holders can trade these coins, similar to any other cryptocurrency. The major difference is that the holder can also redeem the coins for an equivalent amount of USD at any time. Since USD is fairly stable, users don’t have to worry that their money will lose its value overnight. As a result, according to CoinMarketCap, there is currently 180 billion dollars worth of stablecoins in circulation.
Second-ranked USD Coin (USDC) has also seen meteoric growth, with its capitalization growing 806% year-to-date to tag $52.52 billion as of this writing.
Although stablecoins have risen as an opportunity to reduce volatility, various segments of the crypto industry have brought up questions about their centralized nature. Since there is no way for the issuer to prove the number of backing funds, a 1:1 peg of major stablecoins to their backing assets, like the U.S. dollar and other fiat currencies, may not mean much, especially without proper regulation. That said, their potential is still evident in many everyday use cases.
To help prove their use, Binance launched BUSD with Paxos in 2019. A major driving force behind this release was ensuring that every unit of the stablecoin was verifiably backed with U.S. dollars and compliant with regulatory and public standards.
A question of reserves
To give users peace of mind and provide more credibility to questions about reserves, BUSD’s assets in USD are being held in FDIC-insured banks. In a reserve report from Paxos, 96% of BUSD’s total market capitalization is backed by cash and other cash equivalent reserves, and US Treasury Bills back 4%.
To further guarantee these numbers, BUSD continues to be one of the few stablecoins that provide a monthly audited report of their reserves. Therefore, any BUSD holder can verify at any point in time that the supply of BUSD tokens is consistent with the USD being held and managed by Paxos..
Maintaining compliant
The second primary concern with stablecoins today is the current regulation gap, which many believe offers little investor protection, especially in fraudulent activities. Addressing this, BUSD continues to adhere to the highest compliance standards held by the New York State Department of Financial Services (NYDFS). Having a regulator has allowed BUSD to become “Green listed” by regulatory bodies, making it pre-approved for custody and trading by existing virtual currency licenses.
Reserves are being held in the safest forms of assets (i.e., Treasury bills, insured bank accounts).
Reserves are fully segregated from corporate assets and are held bankruptcy-remote according to the New York Banking Law.
This level of regulatory oversight helps maintain consumer confidence in an asset that operates in a largely unregulated industry.
Striving for compliance
With increasing use cases for stablecoins, many believe that the financial industry will be the area that suffers if businesses fail to address these concerns.
For these reasons, Stablecoins continues to operate with an emphasis on compliance. Doing so can safeguard the trust users and regulators have in stablecoins and open more opportunities for both the public and private sectors. As more stakeholders show acceptance for trusted stablecoins, many believe growth opportunities will follow closely behind.
Renewed calls for regulatory oversight
Stablecoins would only be possible in a fully audited system, which is where the importance of regulation comes in. Ironically, a mass migration to stablecoins based on a somewhat unfounded assumption of stability could be the straw that topples the economic Jenga tower.
Recent controversy around Tether (USDT) — the most widely used stablecoin and backed by the U.S. dollar — allegedly not having the dollars to back up their coin have been dismissed by the company and remain unverifiable due to it being essentially unregulated and unaudited.
Regulators around the world must continue to provide more oversight and double down their focus on increasing transparency. In fact, it was one year ago that Bank of England Governor Andrew Bailey made his own statement at Davos warning that crypto lacked “design governance and arrangements for a lasting digital currency” and that “people need assurance that their payments are made in something with stable value.”
Moving Forward
Taking a deep dive into HUBBLE PROTOCOL’s USDH and Lessons from MakerDAO and Liquity
Decentral Park Capital pointed out in its investment thesis, “Hubble is building a primary stablecoin for the Solana ecosystem. We believe USDH can also form the build block for other DeFi protocols that encompass stable assets at the core of their design.”
This assessment puts us in league with MakerDAO and its stablecoin offering, DAI, with around $9.4 billion in circulation. DAI has become the decentralized stablecoin of choice for DeFi on Ethereum and other EVM compatible chains, and Hubble is on track to provide an even more censorship-resistant stablecoin with USDH on Solana.
How Research Focuses Hubble’s USDH Strategy
Keeping the success of DAI in mind, Hubble commissioned a study, the History of DAI Demand, that follows DAI from its launch to the present day.
According to the report’s findings, the widespread use of DAI in DeFi can be attributed to its price stability. As a result, the demand for DAI steadily began rising at the end of 2020 when MakerDAO solved the problem of how to stabilize DAI’s peg. DAI is the “most stable decentralized stablecoin between all the available options.”
What Hubble Learned from MakerDAO
Hubble learned a lot from the steps MakerDAO took to stabilize DAI’s peg. MakerDAO spent years figuring out how to peg DAI closely to $1.00, andHubble should benefit from that knowledge to speed up the process for USDH.
MakerDAO describes DAI’s journey to price stability in The History of DAI at Par Value. There are also hundreds of posts discussing this topic on MakerDAO’s forum, outline of few discussions;
Stability Fee and Savings Rate
DAI’s peg first relied heavily on a Stability Fee (SF) and a DAI Savings Rate (DSR). In theory, the SF controls supply (raise the SF to encourage repayments), and the DSR controls demand (lower the DSR to encourage selling DAI).
These adjustable rates are traditional policies for controlling supply and demand, but they weren’t strong enough to keep DAI well pegged.
It should also be noted that the DSR could be attributed to early demand for DAI. Still, it was an ineffective pegging mechanism, since its leverage bottoms out when the rate can’t be lowered further than 0%.
The Peg Stability Module
A stronger stability mechanism for DAI arrived, however, when MakerDAO introduced a Peg Stability Module (PSM). After this, the PSM seems to have become the most significant source of price stability once the PSM fees were reduced to zero.
The PSM is a smart contract that lets users easily arbitrage USDC (Circle), USDP (Paxos), and GUSD (Gemini) for DAI and vice versa. Swaps made through the PSM are always 1:1, i.e., 1 DAI always equals 1 USDC.
If DAI falls below $1.00, the PSM gives users a risk-free opportunity to profit by burning cheap DAI for USDC. When DAI rises above $1.00, users can swap USDC for expensive DAI through the PSM and swap it back to USDC through another exchange for profit.
Granted, MakerDAO has sacrificed some decentralization by making fiat-backed centralized stablecoins a significant feature of their peg stability mechanism, and this has been referred to as “an existential threat” to DAI with over $5 billion worth of USDC in the PSM reserves.
Choosing What Works for Hubble and What Doesn’t
Since the earliest days, Hubble has been integrating great ideas from other protocols. One standout feature, the Stability Pool, was an idea borrowed from an Ethereum stablecoin project called Liquity.
Hubble litepaper included plans to incorporate many features from Liquity’s elegant design, but Hubble is planning a wider scope of developments that will set it further apart from Liquity.
