How is the Indian Crypto Market Responding?

Ever since the shocking drop in cryptocurrencies over the last week, holdings of Indian investors worth millions have been wiped clean. This heightened volatility in the digital asset market is being attributed to the near-total collapse of TerraUSD, a stablecoin, that was pegged to the US dollar but failed to maintain it.

The algorithmic stablecoin Terra is supposed to maintain a one-to-one peg against the US dollar but slumped nearly to US$0.26 last week. Resultantly, Luna, Terra’s sister token, which powers the Terra blockchain, also dropped below US$0.30 on May 12, 2022 from US$80 within three days.

Because of this crash, crypto assets, which were already witnessing low investor confidence owing to factors like rising interest rates, inflation, and Russia’s war on Ukraine, suffered a major blow – facing losses in double-digits. While Bitcoin lost over 11 percent of its value, Ether lost nearly 20 percent. In response, major Indian crypto platforms CoinDCX, Coinswitch Kuber, and Wazir X have delisted stablecoin TerraUST and Luna after the collapse of the Terra Network. However, some Indian exchanges, such as BuyUcoin, and some global exchanges like Kucoin and FTX have chosen not to delist Luna in the hope that the blockchain ecosystem still has some hope of revival.

In this article, we offer an explainer on stablecoins.

What are stablecoins?

Stablecoins are cryptocurrencies that are collateralized by the value of an underlying asset. They are a tokenized version of the asset and can be introduced subtly into a blockchain ecosystem to facilitate seamless pass transactions, improved arbitrage, and value exchange.

They attempt to maintain a constant exchange rate with fiat currencies, such as the US dollar or the Euro, which can be traded on exchanges. Other stablecoins are pegged to other kinds of assets, such as precious metals like gold or even to other cryptocurrencies.

Stablecoins evolved in order to address the volatility surrounding Bitcoin and other cryptocurrencies with the intention of providing an effective monetary and payment instrument. They are designed to be shielded from volatility that surrounds crypt assets, rendering them difficult for usage as digital assets for payments or as a store of value.

Many stablecoins like Tether, USD Coin, Dai, and others have been popular since 2014 and  Facebook’s Libra proposal in June 2019 further added to the hopes of having a global stablecoin.

What are the types of stablecoins?

• Fiat-collateralized stablecoins: This type of stablecoin is linked to the sovereign legal tenders of countries. Some of the most well-known fiat-collateralized stablecoins, for instance, include Tether and TUSD (True USD). A company issues these tokens by depositing an equal amount of fiat in its reserves.
• Commodity-backed stablecoins: These are stablecoins that are backed by reserved assets other than fiat currencies, that is, by commodities. Real estate, gold, silver, and various other precious metals are examples of commodities. Kitco Gold, for example, is backed by the company’s gold reserves, and the token itself is based on the Ethereum-backed ERC-20 blockchain ecosystem.
• Crypto-backed stablecoins: They are crypto collateralized, that is, backed by other crypto currencies. For instance, Dai is a crypto-backed stablecoin.
• Algorithmic stablecoins: These stablecoins are non-backed in which prices, token numbers, and other variables are controlled with the help of special algorithms, software, and code in order to better manage supply and demand. This strategy allows the company to maintain the reserve peg in the event of price fluctuations.

What are the uses of stablecoins?

Stablecoins can be used as a traditional currency. They have the same advantages as other crypto coins: blockchain security, transaction anonymity, quick transfers, and the lack of intermediaries. They can be used to pay for groceries, fares, or electricity bills, among other things.

Unlike traditional crypto coins, which are subject to price fluctuations and volatility, it is usually believed that stablecoins do not fluctuate much because they are backed by national currencies. However, the recent market crash in case of Terra and Terra Luna, due to the inability of Do Kwon, the creator for both, to maintain their value pegged against the US dollar, raises questions over the stability of stablecoins.

How are stablecoins regulated in India?

There is no explicit law to regulate stablecoins in India as yet. The Reserve Bank of India (RBI) raised concerns about stablecoins in December 2021, highlighting that any crypto asset tethered to the US dollar or any other global currency could destabilize the Indian rupee.

The primary concern is that, in the future, organizations may switch to stablecoins for domestic payments, which could jeopardize the central bank’s ability to oversee currency swings and volatility.

However, despite lack of clarity on their legality, cryptocurrency and virtual digital assets are subject to taxation in India at 30 percent. Read more about taxation of cryptocurrency in India here.