In the world of cryptocurrencies, stablecoins have emerged as a digital medium of exchange with the stability of traditional fiat currencies. Their design pegged to stable assets like the U.S. dollar or Euro, promised reduced volatility compared to other crypto assets such as Bitcoin or Ethereum. However, as the road to financial innovation is strewn with both successes and failures, some stablecoins have faltered, their downfall revealing crucial insights for the crypto community. This blog post delves into the stories of these failed stablecoins, unraveling the reasons behind their demise and highlighting key takeaways that can guide future stablecoin builders
BitUSD was the world's first (not so)-stablecoin, launched on July 21st, 2014 issued on BitShares blockchain and was 1:1 backed by an asset called BitShares. Charles Hoskinson of Cardano was one the team members behind this project. The stability was to be maintained by the “seigniorage arbitrage” mechanism that exists in Algorithmic Stablecoins. BitMEX has done a deep dive into why BitUSD failed. In short, BitUSD was minted at some Loan to Value (LTV) when a user posted BitShares as the collateral. When the price of BitShares fell, the users could exchange BitUSD to the cheaper BitShares, which would prop up the price of BitShares. This mechanism would not work when the price swings were too drastic, as we all now know what happened with Terra Luna and UST. However, back in 2014, it made sense, and the consensus was “why would it trade at any other price other than $1?” The other issue with this model is that it never tracks the value of a real dollar in the real world. There was no oracle as such. With a low liquidity of the collateral, the volatility increased and the peg was eventually lost.
NuBits was a crypto-collateralized stablecoin also launched in 2014. It was over-collateralized by Bitcoin. However, BTC was a highly volatile asset at the time (sometimes still is) and a drastic price drop cause the reserves backing NuBits to drop, resulting in a de-peg. (Just a quick side-note, these days there are insurance providers that insure a de-peg event of stablecoin USDC).
The world started becoming aware of payment stablecoins in 2019 when Facebook and the Libra Association made a high-profile public announcement about their payment stablecoin Libra. Libra was announced to be a global, multi-currency-backed stablecoin, evolving into a US Dollar-denominated stablecoin.
In his Bankless interview, David Marcus mentioned that Facebook’s intention was to bring real-time payments using money designed for the internet, and was trying to build the technology around it.
Libra wanted to be the stablecoin on the Libra Blockchain that could be instantly used by the community of Facebook users, Messenger users and WhatsApp users, with a social component to it. Meaning you could pay anyone across the globe instantaneously while having a conversation with them about the payment. And it wasn’t going to be exclusively controlled by Facebook but by Diem Association, a membership organization of close to 28 companies. Some names included PayPal (now launching its own stablecoin), eBay, Mastercard, Stripe, Visa, Booking Holdings, Mercado Pago etc.
Unfortunately, Facebook was going through a rough time with the user data breach and any brand association with Facebook was not palpable; and so the government shut down the project. The reach that Facebook had with its existing products along with being in control of a monetary network, scared a lot of lawmakers. They wanted to shut it down so fast that the white paper for the stablecoin was published on June 18, 2019 and the team was testifying in front of Congress three weeks later.
The failed project’s intellectual property and assets were sold to Silvergate, which also later collapsed in early 2023 after writing off their Diem investment.
Interestingly enough, in early 2018, David Marcus and his team had conversations with the Bitcoin Lightning Labs team in SF to potentially use lightning as one of the ways to execute the Libra project. However, the Lightning Network just wasn't ready for the scale Facebook was trying to achieve. Ironically, after the Libra project failed, David went on to launch his own venture called Lightspark which is an enterprise-grade gateway to Lightning Network for fast, cost-efficient bitcoin payments.
Through the whole saga of this stablecoin’s short-lived journey, it became clear that stablecoins were aspiring to be a new form of ‘money’, which is why regulators started taking this form of crypto very seriously.
Much has been written about the death spiral of this stablecoin, including a report by Coinchange Research Team. This was an algorithmic stablecoin backed by its own ecosystem’s volatile token called Luna. The ‘seigniorage arbitrage’ mechanism was similar to BitUSD where the stablecoin UST and volatile crypto token Luna could be exchanged by arbitrageurs to maintain the peg. As with the other failures, the significant drop in the price of Luna (some say it was a coordinated token dump by envious competitors) caused the eventual collapse of the stablecoin. Bloomberg reported that this incident wiped out more than $200 billion in a day and its inventor Do Kwon was later arrested.
There are a few other lesser-known stablecoins that have lost their peg. Based on these failures here are some key takeaways:
Collateral Volatility: The stability of a stablecoin is only as robust as its underlying collateral. When collateralized by volatile assets like BitShares, Bitcoin, or Luna, a sharp decline in value can jeopardize the peg. Over-reliance on such volatile assets, without other stabilizing mechanisms, exposes the stablecoin to substantial risk.
Mechanism Design: Systems like BitUSD and UST relied heavily on arbitrage mechanisms to maintain their peg. However, these systems can break down under extreme market conditions or when faced with coordinated attacks.
External Factors: External factors like regulatory pressure and public sentiment play a significant role in the success or failure of stablecoins. As seen with Libra, even with massive potential reach and backing from a tech giant, the project faced hurdles due to the broader context in which it operated.
While the vision of stablecoins remains promising, their practical implementation requires careful consideration of their design, the assets backing them, and the external environment in which they operate. Success demands both technological soundness and adaptability to ever-evolving market dynamics and regulatory landscapes.
Read more about stablecoins and their remittance use case in our latest research report Stablecoin Landscape and the Remittance Use Case, co-authored by The Hedera Network, Myna, UnoCoin, Glo Dollar, Brale and Ethereum Enterprise Alliance.
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