Stablecoins differ from other cryptocurrencies in that their price is “fixed” from inception. Unlike cryptocurrencies like Bitcoin and Ether, whose value is determined by supply and demand, stablecoins are pegged to a fiat asset, like the US dollar.
That said, stablecoin pricing isn’t really that simple. While stablecoin values are pegged to that of a fiat asset, the market does play a role, allowing the price to vary above and below that point based on various market conditions. And, the track record of a stablecoin — or how closely and well it maintains that peg — is a critical factor that can impact asset quality.
Key Elements of a Stablecoin’s Track Record
S&P Global created a stablecoin stability assessment framework that highlights the various factors that impact stablecoin asset quality. Track record is listed as an additional factor that can act as a potential detractor, reducing overall quality.
This aspect of asset quality is broken up into the track record’s stability and reliability. Stability refers to how well a stablecoin has managed breaches or events where its value has deviated from the peg. While breaches are ideally non-existent, the duration and magnitude also play a role, as shorter, smaller deviations are less troubling than longer or larger ones.
The other aspect of track record that the framework highlights is reliability, or the amount of historical data available for a stablecoin. Contributors to this include:
Length: More established stablecoins are more trustworthy than newer ones that may have never experienced a real crisis.
Volume: Higher trade volumes for a stablecoin imply greater liquidity and stronger price discovery, which indicates that a stablecoin can likely weather market turmoil more easily.
Transparency of Price Discovery: Transparent pricing processes — across platforms, venues, jurisdictions, etc. — engenders more trust in the accuracy of pricing and the peg.
Convertibility Across Exchanges: The ability to redeem or convert stablecoins across exchanges with minimal issues or friction shows that an asset isn’t propped up by or dependent on a particular exchange.
Who Cares About a Stablecoin’s Track Record?
A stablecoin’s historical track record may seem like the type of information that is only relevant to investors and users who dig deep into a particular asset before putting their money into it. However, stablecoin track records can impact a variety of different stakeholders in the space — including investors, financial institutions, regulators, and DeFi builders — making it vital for stablecoin issuers to take steps to ensure a strong track record for their cryptocurrency.
Investors
The primary role of a stablecoin is to act as a stable store of value or medium of exchange. The fact that these tokens are pegged in value to fiat assets can help to alleviate potential investors’ concerns about the volatility of cryptocurrencies.
However, this is only true if investors trust that a stablecoin can actually maintain its pegged, theoretical value. Without a history of maintaining a peg throughout various market movements, investors may question the stability of a stablecoin’s peg. This is especially true with horror stories about stablecoins like TerraUSD, which depegged and suffered bank runs and a downward price spiral that resulted in its value going to zero.
Financial Institutions
While decentralized finance (DeFi) was originally created as an alternative to traditional finance (TradFi), financial institutions are increasingly adopting the technology. Cryptocurrencies offer the potential to solve hard problems in the financial space — such as cross-border transfers — and unlock a range of new potential service offerings.
However, like investors, financial institutions depend on stablecoins remaining a stable store of value to facilitate long-term storage or cross-border settlement. For this reason, strong track records are essential to inspire adoption by these organizations.
Regulators
Stablecoins are often regulators’ favorite type of cryptocurrency. Many of the main concerns that regulators hold involve the price volatility and lack of regulatory oversight of the crypto and Web3 space.
By tying the value of cryptocurrencies to fiat assets — which are under regulators’ control — stablecoins help to alleviate some of these concerns and answer some of the important questions that have historically made cryptocurrencies difficult to regulate. This greater trust and comfort helped to inspire the creation of laws like the GENIUS Act in the US, which streamlines and defines the process of creating compliant stablecoins.
Ultimately, the credibility that stablecoins hold with regulators depends on how well they can live up to these promises. If stablecoins suffer frequent or major breaches, where their value deviates significantly from their pegs, this can harm their trust with regulatory authorities.
Builders
Stablecoins have significant potential and a variety of different applications in the DeFi and Web3 space. They’re more acceptable to mainstream users, and they can act as a stable means of value and exchange. For this reason, cryptocurrency exchanges and DeFi projects may work to incorporate or support certain stablecoins to enhance their product offerings.
However, this only works if the stablecoin has a positive impact on the usability of their product or their brand image. A stablecoin with a poor track record in terms of price stability or security may drag down the brand rather than enhancing it. And a stablecoin that fails, losing all of its value due to a bank run and downward price spiral, can result in significant losses for anyone holding it. For these reasons, track records are a major consideration when builders are evaluating stablecoins, especially given the number of available options.
Addressing Top Security Risks to Stablecoin Stability
The stability of a stablecoin’s peg can be impacted by various factors, such as market movements. However, cyberattacks are one of the most significant threats to these pegs. A successful cyberattack could result in significant losses or unauthorized minting of stablecoins without appropriate collateral.
Managing the security risks to a stablecoin’s peg — and protecting its track record — requires considering security at every stage of the stablecoin’s lifecycle. Halborn’s advisory services help stablecoin issuers ensure that they are implementing security best practices and properly testing code, processes, and security controls before they’re deployed into production. Get in touch to find out more.