Stablecoins struggle to survive the crypto crash

Stablecoins struggle to survive the crypto crash

Stablecoins struggle to survive the crypto crash

It has been a crushing few days for the Terra project, in a week that has been unforgiving for cryptocurrency as a whole.

Over the past few days, the stablecoin TerraUSD (UST), which is believed to maintain a peg to the dollar, decoupled dramatically from the $1 mark and fell to a low of less than 30 cents on May 10. In the latest update to the saga, the beleaguered project suspended its entire blockchain for about two hours on Thursday, freezing user funds until the blockchain was not disrupted.

This is a harsh measure, especially given the cryptocurrency’s emphasis on decentralization. “We’ve seen hard forks before, but this is the first time we’ve seen such a large decentralized blockchain system decide to shut everything down,” said Ronghui Gu, CEO and founder of blockchain security firm CertiK.

The chaos was fueled by a steep drop that wiped out $200 billion in value in a single day. Bitcoin alone fell below $25,000 on the morning of May 12, a price not seen since December 2020 and less than half of its November 2021 peak. equally painful days, with Ethereum losing around 20% of its value in just 24 hours.

Terra’s troubles began on May 9 when the price of the UST stablecoin began to drop dramatically. Due to the way algorithmic stablecoins work, this has led to a huge increase in the supply of the corresponding Luna cryptocurrency token, which is traded against UST in order to balance the price.

Adding or removing Luna tokens from circulation was previously enough to maintain a constant price for UST. But the magnitude of the price crash and the corresponding amount of Luna minted — supply more than tripled in a matter of days — sent the two linked cryptocurrencies into a “death spiral” neither of which could. recover.

Currently, the UST is trading at around 40 cents instead of $1; and Luna’s value was almost entirely wiped out, dropping from $100 to around 1 cent.

UST value from May 7 to May 12.  Chart via CoinMarketcap

UST value from May 7 to May 12.
Image: Coin Marketcap

Terra’s nightmarish week makes it clear that stablecoins, which should theoretically hold a fixed price, can actually be very affected by larger moves in the cryptocurrency market – and affect those moves in turn.

Terra is not the only stablecoin facing problems following the cryptocurrency slowdown. Tether’s stablecoin USDT, the largest in circulation, fell well below its dollar peg to trade as low as 95 cents on some exchanges Thursday morning, although the price has since rallied. The measures were significant enough that Treasury Secretary Janet Yellen stepped in to reassure the U.S. House of Representatives Committee on Financial Services that the events posed no significant risk to financial markets as a whole.

Still, the sudden drop is a reminder that the economics behind most stablecoins are still very experimental. “There are fiat-backed stablecoins, but people think it’s too simple – in the world of web3 and blockchain, they want to create great new ideas and innovations,” Gu said. “That’s why there is so much research on the possibility of using algorithms to generate a stablecoin, but so far there are no completely convincing solutions.”

Terra’s future is uncertain, but the sheer volume of untraded Terra Coins presents a huge problem for the project. As more and more coin holders try to cash out, they are likely to devalue the Luna token supply even further, creating what BloombergMatt Levine describes it as “a death spiral”.

But Gu is still cautiously optimistic about the broader future of stablecoins. “The crash shows that people have overestimated what can be done with blockchain and web3 in a short time,” he says, “but they still underestimate what can be done in five or ten years.”

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