Frax Founder Pins $25B Stablecoin Supply Drop on Fed Rate Hikes
The market capitalization of dollar-pegged stablecoins has dropped by $25B in the wake of Terra's collapse.
By: Owen Fernau •DeFi News
When TerraUSD (UST) fell from $1 to $0.09 last week, a huge sell-off shrank the dollar-pegged stablecoin market by 14.1% in a week. Now down $25.34B, the market cap for stablecoins sits at $154.53B, according to The Block.
UST, which all but collapsed after its sister token, LUNA, spiralled into oblivion, was responsible for $18.64B of the drop. Tether (USDT), which briefly fell to as low as $0.95, contributed losses of about $7 billion.
While uncertainty about Tether’s reserves and a loss in confidence in Terra’s algorithmic peg could explain some of the losses, even stablecoins that held firm suffered major drops. DAI’s market cap dropped 18.0%, from $7.87B to $6.45B, and FRAX dropped 43.9%, from $2.64B to $1.48B. The market cap for Abracadabra’s Magic Internet Money (MIM) also lost about $1B.
Impact of Fed Hikes
So why the sudden washout in stablecoins? Sam Kazemian, the founder of Frax Finance, the issuer of the FRAX partially-collateralized stablecoin, said the seeds were planted long before the collapse of UST– things started when the Federal Reserve raised interest rates by 0.25% in March.
“The real reason this is happening is more of a dollar liquidity crisis and dollar purchasing power rising against all assets,” he told The Defiant. “When Fed rates rise, liquidity…gets sucked out [of everything and put] into US treasuries as the risk-free rate rises,” he said.
US treasuries bonds – debt you can buy from the US government – are historically low-risk assets that offer near-guaranteed yields. In May, the Fed raised interest rates again, this time by 0.5%. Rising interest rates meant traders could earn a higher income from treasury bonds.
“The real reason this is happening is more of a dollar liquidity crisis and dollar purchasing power rising against all assets.”
Demand for Treasuries
When interest rates rise, treasury bonds become more attractive than volatile cryptocurrencies like BTC, ETH, and DeFi protocols that offer highly variable yields. So when cryptocurrency prices fell against the dollar, stablecoins became less important for DeFi.
When DeFi trading volumes fall, traders don’t need as many dollar-pegged assets to balance liquidity pools in automated market makers (AMMs), like Uniswap or Curve. And when digital assets fall against the dollar, traders can’t afford to borrow as many U.S. dollar stablecoins.
“Basically you can do much less with the same number of ETH tokens in dollar [terms] so [fewer] dollars/stablecoins [are] needed on-chain,” Kazemian said. “And most of those stablecoins are being redeemed/sucked out of the space into US treasuries.”
He said that the problem isn’t exclusive to crypto – Hong Kong’s central bank, deployed $722M last week to maintain its currency’s peg to the dollar.
“Keeping the dollar peg is about the most difficult thing you can do right now,” Kazemian said. “No one wants dollar-pegged things, they want straight-up dollars themselves to go buy treasuries.”