In contrast to other cryptocurrencies, stable coins should be characterized by value stability. But the TerraUSD crash destroyed nearly $30 billion in assets. And that is just the beginning.
Anyone who invests in cryptocurrencies needs strong nerves – or a lot of money. Course fireworks are part of the daily business, sometimes it goes up several thousand dollars, sometimes down thousands of dollars. What happens less often: Complete crashes like on Wednesday. The stable coin TerraUSD – also known as UST – collapsed to 36 cents per coin and took the cryptocurrency Luna with it. Bitcoin was also affected, slipping below $27,000 for the first time since December 2020. Investors now fear a wildfire that could infect other stablecoins like Tether.
TerraUSD was worth almost $20 billion before the crash, making it the third largest stablecoin. On Thursday, the value was around 60 cents per coin, although by definition this is actually one dollar per coin. This triggered cascading effects that destroyed nearly $30 billion in wealth – nearly as much as Adidas’ market cap. Stable coins should actually prevent exactly that, a crypto crash. In contrast to other digital currencies, they hardly fluctuate, but their value is stably linked to a common key currency, such as the dollar. In short: a coin usually costs one US dollar. The original idea of stable coins was to ensure liquidity in the market and to simplify payment transactions between individual digital currencies.
So why the fall to 60 cents per coin? The short answer to that is that investors have lost faith in Terra – and trust is the most important asset in digital currencies. “What can be said is that trust in stable coins has been massively damaged overall. The image of an entire industry is being battered,” analyst Timo Emden told the “Handelsblatt”.
The technical answer is longer: In order for the stablecoin to be consistently worth $1, those responsible must balance investors’ purchases by investing equally in dollars. So for every coin they deposit a dollar in a different account. At least that is the case with the two larger stable coins, Tether and USD Coin. However, TerraUSD is one of the so-called “algorithmic stable coins”. So behind Terra there are no real dollars, but cryptocurrencies – in this case Luna. A terra is always worth a dollar in luna. Owners can “burn” $1 worth of stablecoins and create (“mine”) Luna of the same value at any time at a fixed exchange rate.
If the price was above one dollar in the past, investors exchanged Luna for stable coins and then sold them profitably on the respective exchange. It also worked the other way around. The course was kept constant for a long time. Until this week, when both courses went significantly into the red. As Terra fell below one dollar, investors logically exchanged the stablecoin for Luna. But when the Luna price also fell, investors also sold Luna. The negative spiral started and ended up hitting Luna in particular. At its peak, the price collapsed to $0.70 before investors lifted it back to over $4.50. On Tuesday, however, it was still over 20 US dollars.
The foundation behind Terra initially rumored that it was an attack on the project. In order to maintain cover, large amounts of their own bitcoins, which the foundation had bought in the past as a hedge, were then sold. But that probably also weakened the Bitcoin price, which fell to its lowest level since December 2020 on Thursday. Investors therefore fear a risk of contagion for the entire market.
In fact, other stable coins are already affected. Tether, the main provider, fell to $0.95 on Thursday morning. Although Tether states that it is fully secured by dollar-based assets, the group does not provide any precise information on this. Last year she was fined $41 million for allegedly making misleading statements about her dollar reserves.
Both the American Federal Reserve, the European Central Bank (ECB) and the Bank of England recently warned against stable coins and their supposedly secure link to fiat currencies such as the dollar. The Fed even warned in its latest Financial Stability Report that “stablecoins may lose value or become illiquid under pressure.” In short, central banks don’t think much of stablecoins. Meanwhile, another narrative is haunting crypto forums: users suspect a conspiracy between large funds and supervisory authorities that are provoking a crash in order to ultimately enforce stronger regulation.
However, given the lack of transparency and the obvious lack of trust, it can no longer be ruled out that other stable coins will be infected by the Terra and Luna crash. How realistic is that? Hard to say. The renowned “Financial Times” comes to the most fitting conclusion on this question. She writes succinctly: “We don’t know.”
It seems unrealistic that the entire crypto scene will come under pressure. But the prices of Bitcoin and Ethereum are likely to feel the crash in the short to medium term, since the foundation behind Terra wants to burn around 1.3 billion TerraUSD in the short term – including around 371 million in the Ethereum cross-chain. This could minimize the supply slope at TerraUSD and bring the price up in the short term. For Terra and Luna owners, however, this is associated with high costs.
This text was first published by “Capital”.
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