Since the failure of algorithmic stablecoins like Iron Finance’s IRON and Terra Luna’s UST, the conversation around stablecoins has changed. Rather than debating which type of stablecoin is best, the focus has now shifted to what type of auditing and reserve system could be most beneficial.

This narrowing consensus is an important shift because it could allow for broadly-accepted regulatory standards. But as the dollar continues to rise (meaning other fiat currencies continue to fall), finding a stable benchmark that will satisfy regulators becomes more difficult. 

Wallex, the creators of the Euro stablecoin EURST believe that using USD exclusively for their reserves is the best way to establish trust with users and regulators. In this article, we sat down with their experts, to learn how the FX market will likely impact stablecoin regulation and how their approach can help with adoption.  

The current state of stablecoin regulation

It is a matter of time before stablecoins will be regulated. Many argue that algorithmic stablecoins aren’t safe and could be banned altogether. Some crypto-collateralized stablecoins have worked so far, but if the cryptocurrency backing a stablecoin is labeled an unregistered security or is associated with criminal activity, it will cause further complications. 

The new US sanctions against the crypto mixer, Tornado Cash represents a new precedent that could indicate stricter enforcement from regulators. For example, mixed crypto collateralized stablecoin issuers like MakerDAO are required to exclude any collateral connected to the addresses on that sanctioned list.

If these risks move regulators to ban algorithmic stablecoins and crypto-collateral stablecoins, that leaves us with fiat-collateralized stablecoins. But in this potential scenario, regulators will still need to provide more clarity on auditing and reserve standards.   

The rising dollar complications for fiat-backed stablecoin standards

For a stablecoin to remain stable, it must maintain its 1-1 peg at all times. Any sustained variation from the coin’s intended value could cause investors to lose confidence and sell their holdings. This risk follows the same pattern of a bank run and can happen to any stablecoin. 

When the value of the US dollar surges, it increases these risks for stablecoins that rely on non-USD fiat reserves. In this scenario, a non USD stablecoin could experience sell pressure across exchanges. This tends to cause the price of the stable to temporarily drop on the exchange – which then increases demand for 1:1 redemptions directly from the stablecoin issuer. If demand is extreme enough and the issuer’s reserves are not adequately supplied, redemptions could be delayed, potentially causing more fear and increasing sell pressure.   

The potential for this type of liquidity crunch is why Wallex believes that overcollateralization is helpful in times of uncertainty. It inspires greater confidence in the peg which can protect against a fear spiral. If stablecoins are only backed by the fiat they represent, then there is a greater perception of risk.

How Will USD-backed stablecoins Like EURST Impact Adoption?

The Euro stablecoin EURST promises a 1:1 backing in USD reserves. They also provide real-time proof-of-reserve attestations through Armanino, one of the top 25 largest independent accounting firms in the US.

Simon Mazzuca, the founder of Wallex, described the organization as a “digital asset ecosystem built on the idea of the future of banking using digital assets. We built an infrastructure that has all the functionality that a traditional bank has, but is adapted to digital assets as well.”

He went on to say, “While being a Euro stablecoin, EURST is backed by US dollars. This has proven to be a successful strategy, given the recent fall in the EUR/USD trading pair.” Forex markets have been volatile lately, with the Euro falling to a two decade low of 0.9903 against the U.S. dollar. The Euro began 2022 at a ratio of about 1.14 Euros to 1 Dollar.  

In fact, EURST has become overcollateralized due to its USD backing. As Mazzuca stated, “Today we have around 8-9% more in our collateral due to the fact that the Dollar has risen against the Euro.” In this way, a stablecoin like EURST can provide protection against inflation while still shielding investors from volatility, he added.

Even though the Euro can return to a higher price, the experts at Wallex argue that the overcollateralization from using a global reserve currency is more important in times of geo-political and economic uncertainty. There tends to be greater risks of bank runs during these periods. 

Another point Mazzuca mentioned was the insurance backing Wallex’s stablecoin reserves. He noted that Wallex’s “custody account for collateral is protected with FDIC insurance. That is two times more than the insurance of the central bank of Europe.” When asked how they managed to achieve this, Mazzuca replied “We have a custody account with our own escrow and every account is insured by FDIC insurance for $250,000. This is another key part to our strategy. [We have a] very macro-economic plan on a large-scale and over a long period.”

In pursuit of their goal of working with both traditional and crypto businesses to enable easy-to-use stablecoin payment gateways, Wallex plans to launch an additional 12 stablecoins by the end of this year.

This content is sponsored by Wallex.

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