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From the right place at the wrong time, to the right place at the right time
Below is a guest post by Vincent Chok, CEO of First Digital Group.
On July 21, 2014, we witnessed the launch of the first stable currencyBitUSD. It was a powerful new concept to hit the market, offering the promise of a stable digital currency that could facilitate transactions without the volatility associated with other cryptocurrencies. Yet, four years later, BitUSD lost its one-to-one parity with the US dollar and has been unable to recover since. BitUSD was not alone. The early years were mired in numerous failures as the structures, infrastructure, and oversight needed to support stablecoins were not yet mature.
Today, the landscape has changed significantly with solid projects and, last but not least, the long-awaited regulation of stablecoins in Hong Kong. As stablecoins celebrate their 10th anniversary, it is time to reflect on their journey so far and why the environment now paves the way for a successful future, proving that stablecoins are now in the right place, at the right time.
Review of previous failures
Ten years ago, the idea of stablecoins was new and exciting, at a time when the world was still reeling from the effects of the global financial crisis. They were seen as a bridge between the volatile world of cryptocurrencies and the stability of traditional fiat currencies. There was also a growing recognition that Web3-enabled digital payment systems could increase the attractiveness and accessibility of stablecoins to the underbanked.
However, many early projects failed primarily due to poorly conceived mechanisms, lack of robust infrastructure, and lack of regulatory oversight. In the case of BitUSD, a detailed analysis by BitMEX Research found that the stablecoin was backed by an obscure, volatile, and non-self-backed asset, BitShares. In the event of a BitShares price decline, a single BitUSD could be used to purchase multiple BitShares, thereby encouraging mass arbitrage similar to traders in traditional asset classes. However, the reverse was not guaranteed, thus creating a structural weakness.
Another notable example is EarthUSD (UST), which maintained its fixed price through an arbitrage mechanism involving its sister token, LUNA. Although innovative, this mechanism had several flaws.
Under normal conditions, the redemption fee was 0.5%, but during the collapsefees skyrocketed to 60%, making it unprofitable for arbitrageurs to reset the peg. Inaccuracies in the Luna Price Oracle contributed to the instability, with discrepancies of up to 70% between the price of the Oracle and the trading price. The delay between the redemption of UST and the sale of LUNA created uncertainty, preventing effective arbitrage. Ultimately, UST’s collapse was exacerbated by a speculative attack and a bank run-like scenario, where heavy redemptions led to a death spiral for both UST and LUNA.
Other stablecoins, such as Acala USD (aUSD) and Deus Finance’s DEI, have also faced significant issues. Acala USD, for example, was brought down by a technical exploit in which hackers managed to mint 1.28 billion aUSD due to a misconfiguration in a liquidity pool.
DEI was targeted in a hack that exploited vulnerabilities on multiple networks, resulting in a loss of $6 million. In hindsight, many of these mistakes could have been easily avoided, however, as is so often the case with emerging technologies, trial and error is part of the process of maturity.
Learning from the past
Today, the stablecoin environment has improved significantly. Learning from past mistakes, modern projects reflect more robust models and thoughtful mechanisms. For example, we have seen fewer uncollateralized algorithmic stablecoin projects enter the market in favor of fiat- and commodity-based stablecoins. Unlike algorithmic stablecoins, collateralized stablecoins do not rely on market forces to maintain their stability and are less exposed to fundamental risk. FDUSD, for example, is pegged to the US dollar, backed by verified liquidity and high-quality cash equivalent reserves that are held in financial institutions.
Modern stablecoins are also built on more secure and scalable blockchain platforms, reducing the risk of technical exploits. Factors include better standards, as well as the fact that the professionalization of the industry has attracted top talent from major tech companies, cybersecurity fields, and more.
Regulatory certainty
In the early days of stablecoins, the regulatory landscape was characterized by a lack of clear guidelines and standards. This ambiguity posed significant challenges for stablecoin projects as they navigated a complex web of financial regulations across multiple jurisdictions. Many early projects operated in a regulatory gray area, leading to compliance and security issues. However, today, regulators are increasingly introducing clearer guidelines that help mitigate risk, introduce good governance, and provide much-needed certainty for projects to thrive.
The Hong Kong Monetary Authority is expected to introduce its stablecoin regime in the coming months. The licensing criteria and conditions are expected to include stringent requirements to ensure the stability and integrity of stablecoins under its jurisdiction. The city is known for developing some of the highest standards in financial regulation and governance through its rise as an international financial hub.
Dubai’s VARA regime also provides an attractive foundation for digital asset companies to build businesses and solutions on the market. Only recently did the Central Bank of the United Arab Emirates approve the issuance of regulations for licensing and overseeing stablecoin deals.
The European Commission’s MiCA regulation also includes provisions on capital requirements, governance and consumer protection for stablecoins.
Interoperability and interchangeability
Regulation will play an important role as regulated stablecoins will have the same KYC and AML mechanisms as Central Bank Digital Currencies (CBDC), creating a level playing field. The interchangeability and interoperability between the two will open up the utility of stablecoins to traditional financial services.
Today, stablecoin use remains largely focused on cross-border payments and remittances scenarios. Proliferation and broadening the scope of its utility must be preceded by increased credibility and trust. Historical issues with well-known stablecoins and heavy exposure to the US market at a time of inherent uncertainty continue to overshadow the sector.
This makes a compelling case for alternatives issued outside the US market and developed with trust-by-design. Features include collateralized, high-quality, audited reserves, unlimited minting, and 1:1 redemption.
In the right place at the right time
As stablecoins celebrate their 10th anniversary, it’s clear they’ve come a long way. Early failures provided valuable lessons that have shaped the development of more resilient and trustworthy stablecoins. As the world continues to change, as risks and uncertainties increase, there has never been a stronger desire from people and businesses for greater trust, certainty, and consistency.
Therefore, stablecoins are in the right place at the right time. Backed by solid infrastructure, emerging regulatory frameworks and increased interoperability. These factors position stablecoins play a transformative role in the financial system, leveraging their inherent programmability to inspire new business models and increase accessibility to the financial system for users around the world.