In the crypto universe, the stablecoin market is in full storm. Why did Terra USD fall? What are the market implications? Decryption.
Wind of panic in the stablecoin market. The collapse of the Terra USD (UST) stablecoin has affected the stablecoin ecosystem as well as cryptocurrencies. BFM Crypto sums up.
• How does a stablecoin work?
A stablecoin (or stablecoin) is a crypto asset (or digital asset) pegged to a fiat currency such as the euro or dollar. A stablecoin can also be backed by other assets (such as gold). This is called the backbone of the stablecoin.
When the price of the underlying asset rises or falls, the value of the stablecoin should match. They promise to constantly maintain parity, for example, 1 UST = 1 dollar. This peg to a currency is also called a “peg”. When there is a gap between the value of the underlying asset and the value of the stablecoin, this is called “depegging” or “loss of parity”.
Stablecoins, most notably USDT (from Tether) and USDC (from Coinbase and Circle), aim to mitigate the risk of volatility in the cryptocurrency market in particular.
There are two main forms of stablecoins:
- The largest (so-called “classic”) stablecoins, which account for about 90% of stablecoin trading today, work like this: a company issuing stablecoins (for example, Tether for USDT) must guarantee that there are as many dollars in reserve as there are dollars. stablecoins in circulation. Thus, if a client wants to sell their stablecoins for dollars, there will certainly be enough money in the treasury of this company to carry out this conversion. So it is a parity based on the supply of “real” money available to the stablecoin issuer.
- Other stablecoins, referred to as “algorithmic” stablecoins, operate on reserves placed in assets other than the underlying ones to which they are pegged, such as digital assets. These algorithms should be able to maintain parity… At least in theory.
• What happened to Terra USD (UST)?
UST (or Terra USD) is the third largest stablecoin in the world with a capitalization of just over $7 billion at the time of this writing. This is the so-called algorithmic stablecoin, which works with the Luna cryptocurrency and cryptographic algorithms. The complex architecture of the algorithms makes it possible to maintain, thanks to the Luna cryptocurrency and a basket of currencies, UST at the level of one dollar, as explained by financial analyst Laurent Pinho in an article published two days ago on BFM Crypto.
However, in the face of a sharp fall in cryptocurrencies, and in particular the moon, the demand for the sale of the latter was so strong that the UST algorithms could not withstand this shock of volatility. Meanwhile, the Luna fund, which oversees the Terra blockchain, bought a supply of bitcoins to be able to intervene if there was a problem: it mobilized the equivalent of $1.5 billion in bitcoins to bring UST back into balance. , but that wasn’t enough.
Today, the price of UST is about $0.50, it even dropped to $0.22, people prefer to sell this asset in a crisis.
“According to the UST, I think the situation cannot be resolved for the people who held it. It is difficult to see how it can go up. Who hopes the UST will return to its $1 mark, this scenario seems to be deviating from the day per day because the protocol burns those last reserves to try and stabilize the device again,” explains BFM Crypto Valentin Deme, a Cryptoast journalist.
There are not so many options for saving the UST: either the intervention of investment funds or billions of dollars of assistance will be required.
• Why did classic stablecoins fall?
Thus, along with UST, there are other so-called “classic” stablecoins. Thus, these stablecoins must guarantee that there are as many dollars in reserve as there are stablecoins in circulation.
However, this Thursday morning, the largest stablecoin, Tether (or USDT), fell below its 1:1 peg, with the dollar trading at $0.97. At the time of writing, it is back to $0.99. “We have rarely seen USDT fall so low, but this is also due to the collapse of UST, people were afraid and preferred to sell other stablecoins,” says Valentin Deme. However, the stablecoin has risen, which can be explained by the current bitcoin drop where people prefer to exchange their bitcoins for stablecoins.
“Tether is being watched very closely right now because if it drops sharply, it will force investors to sell to restore the US dollars. The project can show its limits and bring down the entire cryptocurrency market. Tether has been criticized several times for not having as many US dollars as its capitalization, which currently stands at $81 billion. Indeed, if all investors wanted to withdraw their funds, and the fund did not have enough, this would cause serious liquidity problems,” said Vincent Boy, market analyst at IG France.
“This disaster scenario may lead us to think about the crash of 1929, when everyone wanted to withdraw their money from the banks, but they did not have enough cash in the treasury,” adds the latter.
• What are the implications for companies subject to UST?
The collapse of UST proves that the algorithmic stablecoin principle has its limitations: it specifically explains why most major decentralized finance protocols such as AAVE do not allow UST to be deposited as collateral. Users can borrow UST but not deposit as collateral) . This means that there will be no “liquidity crisis”, says Valentin Deme.
However, other companies have chosen to expose themselves to the UST, in particular those that offer investment services for cryptocurrencies. This is called staking services (loans of cryptography into a blockchain at interest) or lending (loans of cryptography to a borrower at interest), as is done, for example, by the French company Just Mining. Lending is “a verification mechanism that consists of immobilizing a certain amount of cryptocurrencies in order to receive interest,” Just Mining states on its website.
Just Mining has just suffered the consequences for its lending vertical, with the company being exposed to 30% of the Luna blockchain to generate interest in the protocol as part of its lending products. However, there are liquidated pools in decentralized finance that allow the exchange of many stablecoins, including UST, DAI, etc. When the UST fell, their holders sold off so much that the liquidity pool was destabilized. This resulted in a higher-than-expected impact on UST, which rose from 30% to 40%. Just Mining guarantees coverage for its customers affected by potential losses up to $1250.
Just Mining is not the only company affected by this scenario, anyone offering staking or lending cryptocurrencies could also be required to report the impact of the UST collapse.
• What are the long-term consequences?
The collapse of UST and the panic in the stablecoin market “allows us to clean up the stablecoin market,” said Jonathan Herscovici, founder and CEO of StackinSat, a French Digital Asset Service Provider (PSAN) registered with the AMF. . His company decided to use only bitcoins.
“Luna is getting everyone into a bloodbath and it proves that all these very complex systems that offer huge returns are gas factories that are only wasting people’s money. Their own creators don’t even know how it works,” he explains.
According to the latter, algorithmic stablecoins may even resemble Ponzi schemes, “with yield systems almost incomprehensible to humans. Anyone can understand what is behind the bitcoin white paper, so in some cryptocurrencies or stablecoins it is complex and the promise of a return is not kept,” he adds.
For him, this situation also indicates a lack of financial education and understanding of the functioning of stablecoins or altcoins (cryptocurrencies other than bitcoins).
“Investing in cryptocurrencies has to be done by traders whose job it is, otherwise it is almost impossible to understand what is behind the promises of returns from cryptocurrencies. It is very technical, very complex, it should be almost forbidden for the average investor. Marketing messages are difficult promises to fulfill,” emphasizes Jonathan Herskovichi.
Inevitably, the holders of crypto-currencies, whose market has been falling for several days, are paying. This causes a lot of panic, as evidenced by the numerous posts of owners of the Luna cryptocurrency on Reddit.
Jonathan Herkovichi believes that the problem with classic stablecoins remains the same. “The company behind it is clearly in danger of going bankrupt, this is a centralization problem. A stablecoin should be stable, but in the end it is not, and bitcoin is equal to bitcoin,” the latter believes.
As a reminder, the price of bitcoin has fallen by 50% since last November and peaked at $69,000, resulting in big losses for these holders, from individuals to crypto billionaires.
For several months now, many regulators have been calling for regulation of the cryptocurrency market, and in particular the stablecoin market, which currently weighs $1,473 billion for all crypto assets combined.