Just recently, Cardano’s new stablecoin called Djed grabbed headlines for all the wrong reasons. The stablecoin, launched with much fanfare, saw its value fall below the $1 mark, thereby losing its peg to the U.S. dollar.
This event serves as a crucial reminder of the significance of having a robust regulatory framework in place for stablecoin reserves.
On 2nd February 2022, shortly after its launch, Djed, which was marketed as an “overcollateralized” stablecoin, experienced a dip and briefly traded at 97.5 cents.
This happens when the issuers of the stablecoin do not have enough liquid reserves to support withdrawals, causing the stablecoin to lose its $1 value.
Djed’s Over-Collateralization Should Prevent It From Depegging
Stablecoins are a type of digital currency that aims to maintain a steady value of $1. They achieve this stability by being backed by other assets, such as fiat money, other cryptocurrencies, or commodities.
One example of a stablecoin is Djed, which tries to guard against a potential bank run during turbulent market conditions by having a significant amount of liquid assets to back the coin.
Currently, the total value of Djed in circulation is estimated to be $1.8 billion, backed by a whopping $12 billion worth of ADA.
However, despite its over-collateralized structure, there have been instances where Djed’s value briefly dipped. This can be attributed to a sudden decrease in the collateralization ratio, combined with limited liquidity from SHEN holders.
This combination of factors can lead to redemptions being allowed but stops any new minting until more collateral is added.
COTI, the issuer, has set guidelines for using Djed, a new digital currency launched on the Cardano mainnet. To mint Djed, users must send $1 worth of ADA to a designated smart contract.
This smart contract also facilitates the creation of a reserve coin, SHEN, by allowing users to send ADA, which increases the overall ADA and the collateralization ratio of Djed.
However, SHEN holders cannot redeem their coins for ADA if Djed’s collateralization falls below 400% and are also prevented from minting more SHEN if the ratio reaches its maximum level.
Djed holders, on the other hand, have the option to convert their coins back to dollars by sending them to the smart contract, which will burn the Djed and issue an equivalent value of ADA.
It is worth noting that Cardano founder Charles Hoskinson had a public disagreement with former FTX CEO Sam Bankman-Fried last year. In a 2022 vlog, Hoskinson accused The Block, a crypto news outlet, of conducting a smear campaign against Cardano, which Alameda Research, owned by Bankman-Fried, allegedly funded.
The Regulatory Constraints Are Increasing For Reserve Requirements
Stablecoins have been in the spotlight lately due to some recent controversies. These digital assets, unlike traditional banks, are not regulated, and there are no set standards for minimum capital reserves or reserve audits.
To combat this, some issuers like Tether and Circle have decided to publish attestation reports to provide transparency into their reserve compositions.
One stablecoin issuer, Paxos Trust, goes a step further by having a reputable accounting firm, WithumSmith+Brown, prepare a monthly report detailing their reserves for their Pax dollar and BUSD stablecoins.
On the other hand, Tether recently decided to reduce its reserves held in commercial paper and increase its holdings in short-term government treasury bills.
As regulators begin to take notice of stablecoins, legislation is being proposed. The European Union is set to implement rules requiring auditable financial reserves for fiat-backed stablecoins.
A U.S. stablecoin bill is being discussed that could impose a moratorium on non-fiat-backed stablecoins until a report from the Treasury Department can be completed.
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