Last week we learned that stablecoins are not really stable.
The major stablecoin TerraUSD - better known as UST - officially lost its peg to the U.S. dollar, which led to a catastrophic devaluation of its companion cryptocurrency, Luna. Eventually, Terra's blockchain was frozen, it was delisted from most major exchanges, and the value of the Luna coin dropped to zero.
This week has already seen instability in other major stablecoins, most notably DAI.
But that doesn't mean stablecoins themselves are a doomed concept, says Ian Epstein, president of Enigma Securities, a digital broker-dealer that serves institutional wealth clients.
Stablecoins vs. algorithmic stablecoins
"We should talk about what I consider a stablecoin and what is another bad idea masquerading as a stablecoin," Epstein said. "Terra and some of these other coins may call themselves algorithmic stablecoins, but that's really more of a fancy word for a leveraged position that purports to be the asset backing for a stablecoin."
When the leveraged assets can no longer keep up with the stablecoin's liabilities, the structure collapses.
It's a scenario familiar to Epstein, who spent a decade of his career as a macro portfolio manager at Autonomy Capital.
"We see emerging markets all the time that are pegged to the U.S. dollar, but where the central bank's liabilities don't match the asset side of their balance sheet, their reserves," Epstein said. "That leads to excessive pressure on the peg and a devaluation of their currency."
When Terra's assets tilted too far toward its liabilities, it caused a "run on the bank" in the digital economy, Epstein said. "These were Ponzi-like, poorly structured ideas that remind me of every other failed currency peg in history."
Terra's big failure was using non-dollar reserves to defend a dollar peg, Epstein said, but other stablecoins are more promising in terms of actual stability and staying power.
"The USD Coin (or USDC) stablecoin is a money market-like digitization of the dollar run by a company called Circle," Epstein said. "It's pretty transparent - it's really a stable stablecoin that uses technology, not to gain anything. Circle doesn't try to use tractional reserves or leverage. A digital form of the dollar has a useful function, they are offering this product and not trying to be overly greedy. They abide by the rules as they understand them. This is a stablecoin."
Circle uses high-quality short-term paper as an asset to back the USDC token, Epstein said.
Stablecoins have staying power
From a broker-dealer's perspective, Epstein sees the value potential of a stablecoin serving as a transparent, fully backed digital money market fund. "It's very transparent and easy to subscribe to, and it offers great value, as do other true stablecoins similar to USDC that will emerge in other currencies in the next six to 12 months."
Epstein's institutional clients are also taking a close look at the stablecoin space. As interest rates and yields rise, stablecoin balance sheets should improve.
The incentive to create a true stablecoin as a regulated and transparent entity remains intact despite the negative headlines surrounding stablecoins, Epstein said.
Others, such as AdvisorBId founder Brandon Spotswood, believe the collapse of Terra and problems with other stablecoins could lead to tighter regulation and prompt central banks to accelerate work on their own digital currencies.
DeFi: Another area of interest
It may be difficult to understand the institutional interest in decentralized finance (DeFi), a technology designed to disrupt the financial transactions on which many of the world's financial institutions are built, but according to Epstein, the interest is there.
Institutions are attracted to DeFi because of the efficiencies created by smart contracts that enable trustless exchanges with no intermediary third parties to ensure assets are exchanged, and instant settlement of transactions at any time.
"Think of all the economic gains made by companies engaged in this type of activity, and it was a very important activity to create trust bridges," Epstein said. "Now smart contracts do that for us automatically. Think about how long it takes to process a transaction and what percentage of the year the market is open. Everything is now settled instantly, markets can operate 100 percent of the year, and decentralized finance makes it all possible. There is a lot of value in that, and it has nothing to do with algorithmic stablecoins.
Institutions are still taking baby steps
Beyond the stunning collapse of Terra and Luna, the crypto space continues to experience volatile price swings - a problem that could play into the hands of seasoned investors like the hedge funds, asset managers and other institutions served by Enigma.
These investors are still ramping up their crypto efforts and building investment mandates, Epstein said, and most of them suffered few losses during the recent downtrend because they have yet to deploy the bulk of their capital.
"The large institutions are no more impacted in digital assets than they are in fixed income, where the credit markets have hit a rough patch, or technology, which is also down sharply, or emerging markets, which is also down," Epstein said. "There are concerns that the prices and valuations they used to aspire to will be difficult to justify. In some ways, the revaluation of these markets is an advantage for them because they're already further along in accumulating the intellectual and financial capital they can deploy in this space."
Financial capital moves quickly, Epstein said, especially in tumultuous markets as it tries to find safety and value. Human capital is more likely to tell the whole story.
"I've never seen so much human capital in one area - financial capital is always flowing into all sorts of things, markets rise and fall - but human capital, pure geniuses going into a field and thinking about how to use technology, that's the most important sociocultural phenomenon in digital assets," Epstein said. "For that reason, institutional interest and adoption is not going to slow down. The price of Bitcoin is of less importance."