ELi5: why does a stable coin crash?
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It’s not tied to a stable base, as in a country’s currency, gold or other stable investments.
I think they only called it “stable” as it’s brand name, I could be completely wrong, great marketing strategy, however from my understanding all crypto is unstable as a rule… it’s like gambling.
Cryptocurrency was originally intended as an alternative to national currencies, not an investment. Then eventually, some folks started looking at it as an investment. Then it became more and more popular to mine it. You really shouldn’t look at it as a “get-rich-quick” scheme. It’s just supposed to be there for you if your country goes belly-up financially.
Because they were never actually stable to begin with. “Stable” was just a marketing term for what is fundamentally, like most blockchain-related stuff these days, a scam.
A stable coin fails when its underlying assets lose value. Underlying assets can vary and can be multiple in order to create value.
So say for example the dollar is backed by gold. If gold lost value and people panicked the dollar would loose value. But the dollar is no longer backed by gold, so it’s also a scam.
It’s not just a crypto thing.
There’s a few different ways to create a stable coin, people are sorta missing the point by saying it’s “just a marketing term and is actually a scam”. It works almost exactly like traditional currency.
You have a treasury of volatile assets. Every time someone buys some of your stable coin, you give them the dollar amount for this asset (assuming USD here). This goes into the treasury and “backs” the stable coin. You can say that every coin has at least $1 of this volatile asset backing it.
Now just like traditional banks, you decide that you want to expand your treasury. You have a large amount of capital so you decide to invest some of it into different projects. The idea is that people aren’t all going to withdraw at once, so you can spend this money with little risk and hopefully gain value.
Just like traditional banks and currency, this can crash. If the investments all went terribly and you lost a lot of the treasury, suddenly the coin has lost its backing. This causes panic, people cash out the coins and drain the treasury. Now you have nothing backing the coin at all.
The volatile assets can also crash. Usually the treasury wants to be diversified across a large range of assets so that any singular crash isn’t a huge loss. But when a market-wide crash happens, everything loses value, and the backing per coin can massively fall.
Note that there’s other ways to manage the relationship between the coin and the treasury. This is for backed coins, but there’s also the idea of pegging. I assume you’re asking about LUNA UST, it’s a bit different but the same ideas mostly apply.
In the end, the exact same thing happens in traditional currency. The idea of everyone withdrawing at the same time is not new. The idea that they just print more money to keep up with inflation is happening currently. Treasury assets losing value is common. As much as crypto wants to be decoupled from traditional currency, they very much have the same foundations.
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