Terra, the Titanic of cryptography: when the unsinkable stablecoin sinks

One of the most popular projects in the blockchain industry, whose algorithm promised the stability of the cryptocurrency, is experiencing a serious financial bleeding. A fiasco that even affects the price of bitcoin. Analysis.

Necessarily. A stablecoin that loses its balance and sees its price drop by 35% is worth beating. To refresh our memory, let’s just remember that these so-called cryptocurrencies stable rely on all sorts of technical and financial mechanisms to ensure that their price does not fluctuate (too much) depending on the market.

Often these digital tokens find their foothold by pegging their value to a classic asset or currency, not to mention the US dollar. For one purchased stablecoin, the user expects to find a dollar on the accounts of cryptocurrency developers.

Let’s then move on to the Terra stablecoin (UST) in connection with the block chain of the same name. UST is developed on the basis of indirect parity with the dollar using an algorithm that combines Terra’s native token, LUNA. Simply put, UST is needed to create LUNA, and vice versa. The protocol provides arbitrage to keep the price as close to $1 as possible.

By the grace of the decentralized ecosystem, UST was until recently the third stablecoin in terms of market capitalization. Except that on Tuesday its price bottomed out at $0.65 on some trading platforms.

panic movement

Terra began to shake over the weekend under the influence of mass liquidations. The phenomenon of UST “panic selling” at the same time as a huge withdrawal of funds through the Anchor protocol, developed on the Terra blockchain.

Anchor provides decentralized lending services to fintech companies as well as Agriculture (passive income in exchange for immobilizing your cryptocurrency on the platform). A darling of the crypto industry, Anchor claims annual returns of up to 19.5% (!) on blocked deposits. What has recently worked to attract three-quarters of the UST into circulation.

Investors looking for profitable investments naturally flocked to this double-digit platform and needed stablecoins to take advantage of it.

Critics were quick to point out Anchor’s unsustainability: the interest income from loans could not cover the repayment of income, so the whole system would be built on trust. In other words, if investors lose confidence, an inexorable downward spiral begins.

Loss of trust in Anchor rhymes with losses for Terra stablecoin. And vice versa…

Impractical Market Theory?

Market momentum theoretically helps keep the stablecoin price in balance. When the price drops a few cents, investors usually take the opportunity to buy it at a discount and immediately resell it for a dollar a piece.

But given the current drop in the cryptocurrency market, officials at UST, Singapore-based non-profit organization Luna Foundation Guard, feared that their algorithm would be overwhelmed by trading volumes and their stablecoin would be swept away by the falling tide.

Therefore, responsible persons sent funding $1.5 billion in UST and Bitcoin (28,205 BTC!) to guarantee parity with the dollar. The tool did not immediately seem effective, but at the time of this writing, the gap is closing. UST is trading at 90 cents. To be continued.

Meanwhile, with bitcoin already under pressure from investors fleeing risky assets, BTC’s maneuver to keep Terra afloat has likely exacerbated the cryptocurrency’s biggest price drop ever (bottoming last summer, close to 30 000 dollars). This is a bit like a developing country selling its gold reserves to control the exchange rate of its national currency.

Beware the Stablecoin Crash

The collapse of the UST will have repercussions for all decentralized finance (DeFi) and will be a giant wake-up call for regulators who are already deeply concerned about the risks to individuals.

Ironically, the Fed, the US central bank, released a Financial Stability Report on Monday outlining the “vulnerabilities” of stablecoins and their systemic risks.

This category of so-called stablecoin digital currencies experienced strong growth and reached nearly $200 billion. The United States is watching them closely to understand their full potential to solve problems and disputes in cross-border money transfers and payments. Last March, President Joe Biden unveiled an executive order paving the way for “responsible development of digital assets.”

However, the Fed is concerned about the concentration of this sector and the assets backed by stablecoins. ” Assets that may depreciate or become illiquid in a crisis”, the speakers state. ” These vulnerabilities can be exacerbated by a lack of transparency about risks.»