Stablecoins and the Crypto Market Crash – Forbes Advisor UK

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Bitcoin, the barometer of the crypto market, has recently taken a beating. Blame the stablecoins.

Bitcoin hit a 52-week low last week, dropping to $25,402 (£20,360), a level not seen since December 2020. “Digital gold” has since rebounded but, at the time of writing this article, it was still trading around $30,000 (£23,990).

Crypto and global equity markets have been selling off since the start of 2022, thanks to headwinds as varied as inflation, rising interest rates and war in Ukraine.

The recent massive volatility in the market is however something special, directly related to the problems of TerraUSD (UST). This once-popular stablecoin imploded in days, losing 95% of its market capitalization since last weekend.

Let’s take a closer look at the stablecoin market to understand how the failure of a popular coin could crash the entire cryptocurrency market in a matter of days.

What are stablecoins?

In cryptoland, stablecoins come in many flavors. But as the name suggests, a stablecoin aims to provide a “safe” digital asset that maintains a stable valuation.

This is how stablecoins work. Their value is pegged to the price of another asset, most often a fiat currency like the US dollar. The goal is for the stablecoin to retain the same value as its peg.

With a dollar peg, a stablecoin should always be valued at a dollar, no matter what else is happening in the market.

Today, the stablecoin Tether (USDT) is the third largest cryptocurrency by market cap. USDT and its stable counterpart USD Coin (USDC) are pegged to the US dollar. When you buy $10 worth of USDT, you expect it to be worth $10 tomorrow and $10 a year from now.

How does TerraUSD work?

TerraUSD is an entirely different beast from Tether or USD Coin. It is an “algorithmic stablecoin”, backed by nothing more than the magic of computer code.

With an algorithmic stablecoin, a computer program maintains the supply of crypto. Once you understand that there is nothing but code that saves things like UST, you start to see how things could have gone so fast.

So let’s dive into the whole mess of TerraUSD, which plunged as low as $0.23 (£0.18), well below its peg of $1 (£0.80). Crypto experts say the mechanics behind TerraUSD were fundamentally flawed from the start.

In the TerraUSD system, a special crypto token called LUNA is used to help UST maintain its 1-to-1 benchmark with the US dollar.

“This whole system is entirely broken because it relies on a speculative asset – LUNA – to be the collateral,” says Colin Aulds, founder of cryptocurrency storage firm Privacy Pros. “The problem is that LUNA was created with the intention of being collateral simply because the Terra ecosystem needed collateral.”

There was little stable, so to speak, behind this stablecoin other than its programming language.

Why does Terra (LUNA) crash?

LUNA was supposed to protect TerraUSD against market volatility, but it succumbed to extreme selling in recent days. Its trading price has been reduced to $0.03 (£0.02) at the time of writing. That’s down 99.9% since May 6.

“It was inevitable that Terra would collapse as reliance on using other cryptocurrencies as collateral along with LUNA’s mint/burn mechanism for Terra were not enough to survive serious market volatility” , says Adam Carlton, CEO of crypto wallet PinkPanda.

In a bid to save TerraUSD, the Luna Foundation Guard (LFG), the non-profit organization that backs the Terra Network, depleted its entire $3bn (£2.4bn) reserve in Bitcoin. And it was the fund’s dumping of its Bitcoin reserves in a last-ditch effort to save the UST that likely contributed to Bitcoin’s volatility.

Will the crypto market recover?

Although the sun is setting on TerraUSD, all is not bleak for the future of the crypto market.

Ric Edelman, founder of the Digital Assets Council of Financial Professionals and author of The truth about crypto, says what happened this week was a contagion: “During times of panic, people sell indiscriminately. Soon, smart investors realize this is silly, and they recognize that there is a big buying opportunity.

Edelman expects a quick recovery in Bitcoin and Ethereum prices. In his opinion, too many people have bought TerraUSD without caring about how the system actually works, which makes the current situation almost inevitable.

What is the future of stablecoins?

With the implosion of TerraUSD, other stablecoins came under scrutiny, including Tether. Remember, USDT is supposed to be backed by US dollar holdings – and at the time of writing, USDT has a market capitalization of $82 billion (£66 billion).

Skeptics allege that the organization that runs Tether does not have $82 billion to back up its coin.

Last week, the market tested this thesis. USDT fell to $0.97, briefly losing its peg to the US dollar. It has since rebounded to par, but its future health is now in question.

Crypto market participants are expecting some slippage – a USDT is likely to be valued at just under a dollar, as a stablecoin is riskier than a dollar. But it doesn’t take a lot of pennies to vaporize market confidence for a stablecoin.

The market is clearly showing us that secured stablecoins are the future,” says Andrew Pesco, Head of Investment Management at Domain Money.

Collateralized stablecoins like USD Coin (USDC) have proven resilient. USDC is still trading at $1 and even hit a high of $1.13.

Carlton said, “Despite all the harm caused by the Terra Foundation’s reckless approach to stablecoins, we will see the industry ramp up and create even more resilience in the markets.”

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More Stablecoin Regulations Coming Soon

The TerraUSD outcome caught the attention of US Treasury Secretary Janet Yellen, who raised the possibility of stablecoin regulation after it emerged that TerraUSD was in the throes of a crisis and a framework was needed. to guard against risks.

Edelman says there’s no doubt that more regulation is needed to protect U.S. investors: “That effort is underway…and I’m confident that regulation will be in place within the next two years, in the interest of all,” he said.

Cryptocurrency is unregulated in the UK. The UK regulator, the Financial Conduct Authority, has repeatedly warned investors that they risk losing all their money if they buy cryptocurrency, with no possibility of compensation.


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