What would a stablecoin run look like?

Between May 1 and May 16, 2022, a significant run on stablecoins occurred, resulting in their circulation decreasing by 15.58 billion units and market capitalization dropping by $25.63 billion. This event highlighted the inherent instability of stablecoins, despite their design to maintain a stable value pegged to fiat currencies like the U.S. dollar, typically at one dollar per unit. This downturn followed an exponential growth period, with market capitalization rising from $5 billion in 2019 to approximately $180 billion in 2022.

The algorithmic stablecoin Terra, which was the fourth-largest at the time, experienced a catastrophic run and collapse during this period. Its circulation plummeted by almost 8 billion, and its market capitalization dropped by $18.47 billion by the end of May. The algorithmic mechanism of Terra failed between May 7 and May 8, causing its peg to break and its price to fall from $0.9964 to $0.7934. In just over a week, from May 7 to May 16, Terra's market value was wiped out by $17.17 billion, and its associated cryptocurrency Luna lost $20.77 billion.

The instability of Terra quickly spread to other stablecoins, including USDT and DAI, causing broader market concern. However, U.S.-based stablecoins such as USDC and BUSD, which are ostensibly backed by traditional safe financial assets like U.S. Treasury bonds, saw significant inflows. Investors moved funds from riskier algorithmic and crypto-collateralized stablecoins, which saw their circulation drop by 8.70 billion and 2.25 billion units respectively, to these more regulated and perceived-safer alternatives, which increased their circulation by 3.88 billion units. This flight-to-safety mirrored dynamics observed in money market fund runs, where investments shift from riskier prime funds to less risky government funds.

The May 2022 stablecoin run had wider repercussions, affecting the broader cryptocurrency market beyond just stablecoins. Over an eight-day period, approximately $200 billion in crypto market value was wiped out. This event underscores that stablecoin risks are not isolated and can propagate to other asset classes, highlighting concerns about transparency, collateral quality, and the potential for systemic financial instability if the sector continues to grow without adequate regulation.