Flight to Quality: Crypto’s Version of Flying South for the Winter
It feels like we’ve been hearing nothing but doom and gloom from the financial markets this year, especially in the crypto space after the crashes of Terra and Celsius. When these crashes, specifically Terra’s, took place, we saw an immediate “flight to quality” within the cryptocurrency markets- when investors pull money out of assets that are perceived as risky during a time of unsettlement among similar assets and invest in a less risky alternative. These can be asset crashes, a bear market, or any other financial instability. It is ultimately a herd-like behavior, like geese flying south for winter. Terra’s crash was the perfect condition for flight, and now that the dust has settled and we are entering our own colder weather months of the year, let’s take a look at what exactly happened in the collapse to cause this great crypto migration.
What the Flight are These?
First, let’s break down the specifics of who was involved, and what each of their involvement in the stablecoin crash of the century was. As a reminder, a stablecoin is a form of cryptocurrency that is attached to either fiat currency (money), commodity (precious metals or gems), or algorithm (connected to another form of cryptocurrency) in order to give it a more “stable” price.
The players in this scenario are Terra, Tether, and USDC. Terra was a blockchain platform that powered a stablecoin network that supported its stablecoin, UST, which was backed by LUNA, Terra’s own currency, making it an algorithmic backed stablecoin. Tether, on the other hand, is a blockchain platform that powers a stablecoin network that supports its coin, USDT, which is backed by the US dollar and other assets, making it mostly a fiat-backed stablecoin. USD Coin, or USDC, is a fully reserved stablecoin that is entirely backed by the U.S. dollar alone.
What the Flight Happened?
In early May, a large amount of capital was suddenly, and unexplainedly, pulled out of Terra, causing the price of LUNA to drop and pull away from the U.S. dollar it is supposed to match, causing it to destabilize, or depeg. As prices started to drop, people started to panic and tried to offload as much of it as possible, making it crash faster, until it hit a rock bottom and investors were not able to pull out any more funds.
Terra’s collapse then prompted an increase in investments in fully fiat-backed stablecoins and a decrease in “stable-ish” coins backed by algorithms and not entirely fiat-backed, putting coins like Tether in the hot seat of this most recent flight to quality. In the week following Terra’s crash, investors panicked and pulled over $7 Billion out of Tether, causing the market value to drop 9% in just five days.
Terra’s collapse and purchasing trends moving away from Tether did not harm the reputations of fully fiat-backed stablecoins like USCD, however. Instead, it ended up proving their quality, value, and resiliency during unsure financial markets. In that same time period in mid-May when Terra’s value plummeted, Circle’s USD Coin’s funds grew by 5%, with a net weekly increase of 2.3 billion USDC coins in circulation in just one week, showing a direct current from algorithmic to fiat-backed stablecoins- the textbook definition of a flight to quality.
What the Flight Does This Mean for Stablecoins?
Stablecoins still had to do their part to lay low, but they remain a significant part of many investors’ portfolios. Even in the face of a major collapse, both the market for stablecoins and the broader crypto market are showing resilience and signs of adaptation. While times of volatility are never ideal, they provide an excellent opportunity to identify what is working and what perhaps is not, allowing for refinement and course correcting to guide the evolutionary nature of the market. The algorithmic stablecoin proved to be a risky experiment but ended up creating more trust in fiat-backed coins such as USDC and better-known digital assets such as Bitcoin. Thus, the market held up, is showing signs of recovery, and will be strengthened.
Is This the Final Stablecoin Flight?
Most likely, not. However, as markets shift, sentiment and affinity for particular coins waxes and wanes, and meme coins come and go, fiat-backed digital currency will stay the course and remain a constant. As the digital asset space evolves, stablecoins are committed to enabling all citizens to be able to participate in all aspects of digital transactions and asset utilization. We are excited for what is on the horizon for the space and our clients in it and look forward to seeing what stable staples will end up in every investor’s wallet soon enough.