Earlier this week, Cardano’s recently-launched stablecoin Djed lost its peg to the U.S. dollar, drawing attention to the importance of regulatory frameworks governing stablecoin reserves.
On Feb. 2, 2023, days after its ballyhooed release, Cardano’s “overcollateralized” Djed stablecoin briefly dipped below the $1 mark to around 97.5 cents. Stablecoins lose their $1 value when issuers do not hold sufficient liquid reserves to honor withdrawals.
Djed’s Overcollateralization Should Prevent Depegging
Stablecoins are digital assets that use fiat, other cryptocurrencies, or commodities to maintain a value of $1.
Coins like Djed try to avoid a bank run scenario during times of market stress by over-backing their coins with liquid assets. The circulating supply of Djed is currently worth $1.8 billion, backed by $12 billion worth of ADA.
Considering its over-collateralized nature, Djed’s brief dip could have been caused by a sharp drop in collateralization ratio, accompanied by insufficient liquidity from SHEN holders. This scenario allows redemptions but prevents additional minting until more collateral is added.
According to issuer COTI, Djed’s collateral must stay between four to eight times the amount of Djed minted. A user must send $1 of ADA to a smart contract address to receive one Djed. Users wishing to mint a reserve coin SHEN must send ADA to the same smart contract, adding to the overall ADA and increasing Djed’s collateralization ratio. SHEN holders cannot redeem their coins for ADA as long as Djed’s collateralization ratio is below 400%, nor can they mint more SHEN when the ratio reaches its maximum value.
Djed holders can redeem their coins for dollars by sending them back to the smart contract. The smart contract burns the Djed and issues $1 worth of ADA.
Layer-1 blockchain COTI and Cardano IOG recently launched Djed on the Cardano mainnet.
Last year Cardano founder Charles Hoskinson accused former FTX CEO Sam Bankman-Fried of attacking Cardano through the media. In a 2022 vlog, Cardano co-founder Hoskinson alleged that crypto news outlet The Block embarked on a Cardano smear campaign while Bankman-Fried’s Alameda Research extended loans to The Block’s former CEO Michael McCaffrey.
Regulatory Noose Tightens Around Reserve Requirements
Recent stablecoin blow-ups have increased regulatory scrutiny. Because stablecoin issuers are not regulated like banks, regulation surrounding minimum capital reserves is scant. Additionally, no accounting standards govern the scope of reserve audits. Centralized issuers Tether and Circle have instead committed to publishing attestation reports to provide a window into their reserve compositions.
Paxos Trust, issuer of the Pax dollar and the Binance-branded BUSD stablecoins, issues attestations after each month’s end detailing its reserves. Independent accounting firm WithumSmith+Brown, PC, compiles the reports. Tether recently reduced the portion of its reserves held in commercial paper for short-term government treasury bills.
Upcoming legislation by the European Union mandates auditable financial reserves held in banks for fiat-backed stablecoins. A proposed U.S. stablecoin bill by the House Financial Services Committee seeks to impose a moratorium on non-fiat-backed stablecoins pending the findings of a Treasury Department report.
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