The End of a Stablecoin — The Case of NuBits
By: Reserve Research Team
Tags: Cryptocurrency, Stable Coins, Blockchain, Economics, Bitcoin

In 2016, NuBits’ peg infamously broke, and it remained broken for 3 months. The initial price drop happened between May 26th and June 20th, 2016. This was about the same time that Bitcoin’s price suddenly spiked, after 6 months of relative stability. It’s plausible that the drop happened because of the following: People who had capital in NuBits saw how Bitcoin was spiking. They wanted to get in on the spike, so they sold their NuBits in large quantities to buy Bitcoin. The NuBits peg was unable to handle the large sell-offs and broke. The price tanked and the peg stayed broken for an extended period.

It seems that when the Bitcoin and volatile cryptoassets’ prices spike, investors with capital in stablecoins will want to sell them off to get in on the spike. That causes strong downward pressure on the stablecoin price.

The January NuBits boom

After NuBits crashed in 2016, its market cap grew 1,500% on Coinmarketcap between the end of 2017 and the beginning of 2018, going from $950k to $14 million. This is strange, considering the NuBits peg had been broken for such a long period in 2016. Their market cap had been stagnant for years, and suddenly it takes off. Was this spike just an accounting error, or had people suddenly decided NuBits was actually amazing?

Turns out the increase was real. However, it did not happen in one day. People were buying millions of NuBits in late December. The price of the NuBits stablecoin was notably above its $1 peg between December 20 and December 28, when it peaked close to $1.50(!).

What caused the increase? It’s clear when one looks at the Bitcoin price history. The NuBits high price period starts when Bitcoin had its “Christmas crash.” By December 22 there was a strong news narrative about Bitcoin crashing.

As long as there was a lot of uncertainty about Bitcoin’s stability, people kept buying large numbers of NuBits. Then, by the New Year, when Bitcoin temporarily normalized again, the large NuBits buy-ins stopped.

What happened, then? Well, Bitcoin holders noted the dropping Bitcoin prices and got worried about an imminent crash. Converting BTC to USD is slow and can lead to taxation. So the worried Bitcoin holders converted their crypto assets to stablecoins rather than cash. Some choose NuBits. The very large influx of Bitcoin money doubled the NuBits market cap several times over. The NuBits folks were frantically printing new money and selling it off to the Bitcoin holders. But demand was so great among panicked Bitcoin holders that the new NuBits couldn’t be printed fast enough and their price was driven up high.

This shows how when Bitcoin and cryptomarkets crash, capital rapidly flows into stablecoins.

The lesson from NuBits’ first crash

If the crypto market is efficient, then you would expect there to be increased demand for stablecoins in crypto bear markets and strong rapid downward pressure on stablecoin price in crypto bull markets. The case of of NuBits seems to confirm that there is efficiency on this front and that market actors are behaving rationally.

However, one can’t help but ask: will all stablecoins suffer the same fate as NuBits? Will they collapse under the downward pressure created by crypto bull markets?

In short, no.

Yes, NuBits faced a lot of downward pressure as people sold it off to try to get in on a Bitcoin spike. But the crash ensued because the NuBits protocol wasn’t designed to be able to deal with it.

This kind of drop happens in phases when a stablecoin is exposed to a lot of volatility due to demand not being diversified. The way to deal with these cycles of downward pressure — caused in part by lack of diversification — is to have large reserves, potentially many times over circulating supply, which can be quickly used.

NuBits had only a small, fractional reserve that was not algorithmically controlled. It could not be used to automatically, with arbitrageurs, cover the drop in demand and keep the price unaffected.

Thus, NuBits’ first crash was a consequence of its design. But what about its second crash?

The end of a Stablecoin — again