Stablecoin, you had one job …
If a ‘stablecoin’ that’s merely supposed to mimic a dollar is priced at 30 cents, something has obviously gone very wrong.
While most cryptocurrencies are famously volatile, the so-called ‘stablecoins’ are supposed to be a safe harbour, somewhere to park value digitally, in between higher risk crypto trading. The idea at surface level is quite simple, the value of these assets are intended to be a ‘peg’ to a FIAT currency, most commonly the US dollar.
Traders can switch into an asset akin to dollars without the delay of going to real-world cash.
It is a simple idea in concept though it appears that complexity and computer science has been the undoing of TerraUSD – otherwise known as UST – which has lost more than half its value over the last 24 hours, and some of the intricacies threaten to create yet more turmoil for cryptocurrency markets.
UST is today ‘un-pegged’, whilst its intertwined Luna crypto token is similarly on the rocks falling 85% today to US$4.25 versus a very recent April all-time high of US$118.
How does the stablecoin work?
UST is built on the Terra Luna blockchain and unlike some other stablecoins it doesn’t simply represent an underlying vault of FIAT currency, instead, it has been designed to algorithmically track, or virtually simulate the real-world dollar value.
Conversely, collateralised stablecoins are backed with an equivalent value of some other value store. Dollars are most common though other fiat currency pegs are also possible, as well as stakes in gold and also other cryptos.
The Terra system is backed by other crypto assets, namely Luna coins which themselves represent a portion of Bitcoin. Smart contracts, controlled by algorithms control the volume of these tokens in circulation – creating more when the Dollar value changes and even ‘burning’ excess tokens when necessary.
Terra’s problem was that the dollar is being devalued, at the same time as Bitcoin is depreciating in value and as swathes holders of UST and Luna are pushed into panic selling.
What happened?
So far, everyone remains coy about whether some specific event triggered the initial collapse in confidence, or whether the algorithm was fundamentally borked as soon as a certain level of volatility emerged.
The apparent consensus among commentators is that the algorithm failed to maintain ‘the peg’ as runaway inflation devalued and, separately, the price of Bitcoin crashed.
By the time that the boffins behind Terra came to liquidate Bitcoins in reserve, they had lost some 54%.
Naeem Aslam, a market analyst at Avatrade adds that the plunging prices of Bitcoin, which is supposed to act as a reserve “created a double bogey for the stablecoin.”
Naturally, as the price of the stablecoin diverges with the US Dollars that it is supposed to mimic, more confidence is lost in the marketplace.
The experimental algorithmic approach spectacularly failed to maintain stability – UST has fallen some 50%, some way away from the intended $1 and at one point was priced down at a mere US$0.50.
The price in the market for Luna has dropped down to US$4.25, a far cry from last week, when it was trading at nearly US$90.
What next?
Co-founder of Terra Do Kwon said in a series of tweets that a plan is underway to return UST to its pegged value.
That plan involves minting more LUNA, four times more than usual, in what the crypto world is calling “Kwontative easing.”
Essentially, Kwon hopes that increasing the amount of LUNA in supply from US$293mln to US$1.2bn will bring UST’s value back to US$1.
However, that may take some time to achieve, and the implications on the wider crypto market could be “very significant.”
Like intangible, ‘real world’ financial systems the so-called contagion risks can outweigh even the most dramatic short-term losses.
In the case of Terra, and more broadly general crypto markets, the fear is over the third party crypto ventures and projects which have either embedded or integrated UST, or groups which may have used UST as collateral.
Marcus Sotiriou, an analyst at GlobalBlock said that we will soon find out which decentralised finance projects are impacted by UST, and, that may result in prominent protocols “going under.”
Sotiriou adds that there is “now a fundamental risk to the crypto industry”.
He adds that the dumping of Terra’s Bitcoin reserves would further stir up fear and volatility.
Moya adds that for time being, Bitcoin is holding up above US$30,000 “but if another mass exodus occurs, that could lead to widespread selling across cryptos.”
For a market that has already taken a massive tanking this year, the latest instability is a huge blow.