The Problem with Stablecoins

By Nelson Yan

Stablecoins have recently become the talk of the crypto world. Stablecoins, often pegged to a fiat currency like the dollar, are supposed to be relatively immune to price volatility, though the recent price cash of USDT, the most well-known stablecoin, shows that this is not always the case. Since then other stablecoins have risen to challenge USDT’s lead, and appear to have a bright future. But there are dangers ahead. 


The problem with stablecoins


It’s easy to understand the demand for stablecoins, especially in countries like China. Last year China first restricted fiat transactions to cryptocurrency exchanges, and then shut down domestic exchanges altogether. For many Chinese, stablecoins are a fiat alternative that can be used in exchange for crypto. 


The problem is that not only have stablecoins inherited the pain points of traditional fiat currencies, they come with some new ones as well. Here are a few: 


The temptation of over-issuance


There is nothing new under the sun. Even though cryptocurrency is supposed to avoid the problem of central banks printing too much money, any stablecoin issuer will be naturally and constantly exposed to the temptation to over-issue their own coin. After all, that kind of business can become extremely profitable with hardly any cost.


Lack of trust in centralized providers


A higher degree of trust is required for stablecoins provided by centralized organizations, because any risk inherent in these organizations can be instantaneously passed to the holders of stablecoins they issued. Moreover, the level of trust will need to increase alongside the rise of stablecoins’ market capitalization. In most cases, a stablecoin’s level of trust will eventually fall far behind its market capitalization. 


Unstable market value of virtual collateral and lack of trust in fair price


Let’s take a look at DAI, which calls itself “the first decentralized stablecoin on the Ethereum blockchain.”  DAI is collateralized with virtual currencies, which have their own high market value volatility, indicating frequent margin calls and position closing maneuvers. This is the first risk of decentralized stablecoins. But think more deeply and you’ll see the second risk: Based on which price should a smart contract close a position? Maintenance of this fair price may again lead us to the same problem of trust-facing centralized institutions.


Lack of effective AML solutions


If they want to comply with regulations, stablecoins have to assume at least some responsibility to fight money laundering. The stablecoin TUSD, for example, requires users to complete a KYC/AML process before purchasing TUSD or redeeming TUSD through their web application.  This does not mean, however, that all the holders of different stablecoins need to pass this test. Instead, only participants involved in a primary transaction have to do it. That is to say, holders of stablecoins can get rid of the regulators after one single transaction, which drastically raises the difficulty of fighting money laundering. 


Contradiction between on-Chain stablecoins and “code is law”


When stablecoins first appeared, they were more of a bond than a virtual currency. As a result, it seems even more reasonable to ask for the intervention of issuing institutions in the case of a hack. This is a sharp contrast from the world of virtual currencies, in which “code is law” and there is no central authority that can come in and clean up a mess. The expectations may be different for stablecoins, but its hard to say whether stablecoins could really be helped by their issuing institutions.  


The example of HUSD: Huobi’s Stablecoin


As a veteran exchange, Huobi has recently provided a new solution to stablecoins by creating a new one named HUSD. Users can receive HUSD by depositing PAX, GUSD, TUSD or USDC and withdraw any of these 4 stablecoins on a 1-to-1 basis. Huobi has listed trading pairs against HUSD on its traditional market and OTC exchange. Supposedly the total amount of HUSD should not exceed the sum of PAX+GUSD+TUSD+USDC, and the real value of HUSD is the arithmetic average price of the four stablecoins that it currently holds. The accompanying chart shows HUSD's theoretical circulation as well as the collateral distribution of those four stablecoins. 


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The intention behind HUSD is good, and it neither violates regulation nor appears to be fake money. The introduction of another stable coin can also help dilute the risks of Tether’s dominance. However, does HUSD face the same problems listed above? 


Temptation of over-issuance


The distribution of HUSD is not based on any blockchain, so it is completely uncontrollable in the case of additional issuance. All we can do is to simply trust the Huobi platform. Even though Huobi behaves well, what if the four stablecoins pegged to it were over issued, leaving Huobi to face the consequences?


Lack of trust in centralized providers


In fact, HUSD has been issued based on the initial distribution of another stablecoin. While such link-based distribution involves two centralized institutions, any crisis of trust, either in Huobi or the related stablecoin distributor, could undermine the stability of HUSD as a whole. 


Fluctuating collateral prices 


Unlike decentralized stablecoins, HUSD does not rely on highly volatile virtual currency as a collateral, instead it can be regarded as being collateralized by the other four stablecoins. Therefore, if the price of one stablecoin making up a higher percentage of total collateral fluctuates significantly, it will inevitably affect the price and trust of HUSD. As we saw in the case of Tether, sometimes the value of stablecoins is not that stable.


Lack of effective AML solutions


Compared with stablecoins on a single blockchain, HUSD is difficult to track, which is even less friendly for AML. For example, you can easily deposit one kind of stablecoin and withdraw another.


The “code is law” problem


At present, HUSD can only be swapped for four ERC20 stablecoins. If there is an increase in the number of stablecoins pegged to HUSD the risk of double-spending and on-chain stealing will only worsen.


The cryptocurrency world is just too vulnerable to face another stablecoin crash. That’s why it’s a good idea to pay close attention to HUSD before another stablecoin crisis breaks out.



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