A selloff is currently hitting cryptocurrencies, and one, in particular, is beginning to look like an emperor with no clothes.
TerraUSD, a so-called “stablecoin,” because of its purported peg to the dollar at 1 to 1, has lost around half its value overnight. The loss was so great, according to industry analysts, that it could even enter what’s known as a “death spiral.”
According to The Wall Street Journal, TerraUSD uses ” financial engineering to maintain its link to the dollar.” Does that sound very “stable,” to you? Caitlin Ostroff and Elaine Yu explain the breakdown, writing:
The break in TerraUSD’s peg began over the weekend with a series of large withdrawals of TerraUSD from Anchor Protocol, a sort of decentralized bank for crypto investors.
Anchor Protocol is built on the technology of the same Terra blockchain network that TerraUSD is based on. It had been a major factor in the growth of the stablecoin in recent months by allowing crypto investors to earn returns of nearly 20% annually by lending out their TerraUSD holdings.
At the same time, TerraUSD was also sold for other stablecoins backed by traditional assets through various liquidity pools that contribute to the stability of the peg, as well as through cryptocurrency exchanges. The sudden outflow of money spooked some traders who began selling TerraUSD and its sister token Luna. Before its peg was broken, TerraUSD was the third-largest stablecoin with a total market value of $18 billion.
TerraUSD’s fall to 23 cents at around 3:30 a.m. ET marked a 70% drop from its value 24 hours earlier, according to CoinDesk.
Even as TerraUSD began regaining some value after hitting its low, Luna continued to fall. The token was down 97% from the previous 24 hours at 8:53 a.m. ET, trading at 99 cents.
“I understand the last 72 hours have been extremely tough on all of you—know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this,” wrote Do Kwon, the South Korean developer who created TerraUSD, on Twitter on Wednesday.
Stablecoins have surged in popularity the past two years and now act as the grease that moves the gears of the cryptocurrency ecosystem. Traders prefer to buy coins such as bitcoin, ether and dogecoin using digital assets that are pegged to the dollar because when they buy or sell, the price is only moving on one side. They also allow for fast trading without the settlement times associated with government-issued currencies, which can take days.
The price of bitcoin fell to $29,460.20 Wednesday, down 4.8% from its 5 p.m. ET level Tuesday. It has lost about 25% of its value over the past week alone.
In the past, TerraUSD maintained its $1 price by relying on traders who acted as its backstop. When it fell below the peg, traders would “burn” the stablecoin—removing it from circulation—by exchanging TerraUSD for $1 worth of new units of Luna. That action reduced the supply of TerraUSD and raised its price.Conversely, when TerraUSD’s value rose above $1, traders could burn Luna and create new TerraUSD, thus increasing the supply of the stablecoin and lowering its price back toward $1.
Such a model has drawn criticism because it relies on people’s collective willingness to support the cryptocurrency. Without that, the stablecoin can quickly sink, in what industry participants have described as a “death spiral.”
Action Line: Your Survival Guy believes in the potential value of blockchain technologies, but anyone looking to avoid volatility should probably avoid cryptocurrency speculation. Instead, invest in the power of compound interest and individual securities. If you need help, let me know.
