How Crypto’s Crash Broke The Buck For TerraUSD

Cryptographic critics who believe the industry is nothing more than a series of intricate ponzi schemes are inflating their chests today.

TerraUSD (UST), a digital token with a market capitalization of $ 16 billion that is designed to maintain a 1: 1 ratio with the dollar, known as stablecoin, has fallen in the last 24 hours. Its price has dropped below $ 0.65, before recovering slightly to $ 0.93 at the time of writing this article. In other words, UST failed dramatically in the only thing it had to do: maintain parity with the dollar.

The episode recalls when the Reserve Primary Fund, a $ 68 billion asset-backed money market mutual fund, fell from $ 1 a share in net asset value to $ 0.97 during the financial crisis after Lehman Brothers declared in bankruptcy in 2008. He owned the Lehman trading paper, the collapse of the investment bank caused panic among money market fund holders who rushed to rescue shares. Money market mutual funds were thought to be as secure as FDIC-secured savings accounts.

In terms of TerraUSD, the fall fell on the same day that the Federal Reserve issued its semester Financial stability report, in which stable currencies occupied a prominent place. The report noted how stable currencies can be subject to money market fund races, especially during times of stress when the assets supporting these tokens can become illiquid.

So what exactly happened to UST? To begin with, it is important to consider what makes the asset unique, or dangerous, within the world of stable currencies. UST is a algorithmic stable currency, which means it operates differently from most similar assets. The most popular stable currencies, such as tether (USDT – $ 82 billion market capitalization) and USD Coin (USDC – $ 50 billion market capitalization), are backed by assets such as trust dollars in a bank account, treasury or debt. short-term commercial. This approach is also dangerous as issuers have sometimes been opaque about the exact breakdown of their reserves, the USDT has been especially controversial and observers are concerned that these assets do not have enough liquid collateral to rescue the $ 100 billion in assets they support. . .

That said, they appear to be a model of stability compared to the UST. Instead of being backed 1: 1 by tangible assets in a bank or depository, UST uses a complicated setup with another token, LUNA, to try to maintain its link. LUNA is a native token of the Luna blockchain, a decentralized platform like Ethereum that can run various types of applications such as decentralized financing programs (marketing and lending) and support non-fungible tokens (NFT). Each UST is of course to be redeemable for $ 1 from LUNA, currently priced at $ 30.00

Of course, prices fluctuate just like in the fiat world. The exchange rate of one dollar against other currencies is adjusted daily. In the UST world, LUNA is supposed to be a stabilizing mechanism to help return the UST price to $ 1 when it deviates. If the UST falls below $ 1, there would be an arbitrage opportunity to buy a UST for, say, $ .98 and then exchange it for $ 1 on the MOON. Finally, this trade should synchronize the price.

The system looks sleek on paper and a bit clever in financial engineering, but untested. In the past there have been several unsuccessful attempts to create a stable algorithmic currency. For example, about a year ago, a token that supported IRON stablecoin, called TITAN, crashed to zero amid market uncertainty in what the team called “the world’s first large-scale cryptocurrency.”

It appears that Luna has tried to learn from these failures and is concerned that some buyers may be concerned about the underlying value of LUNA, so it has also bought more than $ 3 billion in Bitcoin and Avalanche as an additional stabilization mechanism for the protocol.

Last weekend, UST began to deviate from $ 1 as macro uncertainty continued to rise in light of the 50 bp rate hike on Wednesday, concerns about April inflation numbers, released tomorrow, and double-digit falls affect most cryptographic tokens in recent days. There have been some allegations that an unknown actor was trying to flood the market with UST to attack the protocol, and a pseudonymous actor even took a very public $ 10 million short position against the asset.

While all this was going on, more than US $ 5 billion was being removed from the Anchor Protocol, a DeFi loan application running on Luna. This accounts for about a third of all market capitalization, which could be seen as a vote of no confidence in the asset. Anyway, this must have happened at some point. Participants in this protocol had received an unsustainable performance of 20% in their wait, which is abnormally high, even for crypto. Eventually this was going to relax.

As you can see above, the ball of yarn began to relax over the weekend, and even as Luna’s team deployed all the bitcoin at their fingertips, as well as hundreds of millions of dollars in UST to market makers in a effort to achieve liquidity. and recovers things to balance, not recovered. It may never be, and even if it does, the damage to reputation will be almost impossible to overcome.

To make matters worse, the collateral damage was substantial. LUNA has seen its market capitalization fall from more than $ 30 billion to $ 10 billion in the last five days and its price has dropped 64% in this time period. In addition, as the team flooded the market with bitcoins in an effort to protect pricing, it added more selling pressure to that asset, seeing it fall below $ 30,000 for the first time since last July. In total, the market capitalization of the cryptocurrency has lost about $ 300 billion in recent days.

If there’s one saving grace here, it could be that other major stable currencies like USDT and USDC have managed to avoid damage to a great extent. However, as they continue to grow in size, it is fair to assume that regulatory scrutiny will only grow in light of these events.

It is also fair to wonder if or when there will ever be a successful algorithmic stable currency. UST has increased in large part due to the violent reaction among the natives of cryptography to the centralized way in which USDT and USDC operate, which they consider anathema to the ideals of cryptography. Of course, decentralization is a spectrum, so there may be a middle ground between purely algorithmic tokens and the decentralized model. Regardless, no record will succeed until it can prove its viability during times of stress, something the traditional financial sector is also struggling with today.

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