First Mover Asia: Bitcoin at 16-Month Low as UST Collapse Shows Risks of 'Algo' Stablecoins

Bitcoin fell to $27,700 at one point to a new 16-month low before regaining some ground, but it was still part of a mass sell-off of digital assets triggered by terraUSD (UST) stablecoin implosion against its 1:1 dollar peg.

"It is a very nervous time in crypto markets following the collapse of the controversial stablecoin UST and as the majority of institutional crypto investors that invested last year are now losing money," Oanda Americas Senior Market Analyst Edward Moya wrote.

Terra blockchain LUNA token token, which was created as a buffer against the volatility of UST stablecoin plunged 96% at one point after the Luna Foundation Guard, the non-profit established to support the Terra network, moved its reserves to bitcoin exchanges to defend the dollar peg. 

UST dropped as low as 23 cents before recovering to 77 cents later in the day. Stable it wasn't.

Bitcoin, the largest cryptocurrency by market capitalization, was recently trading at $28,500, down about 7%, although it fared better than most other major cryptos, underscoring its status as a less risky option during tumultuous times for the wider digital assets market. 

Ether, the second-largest crypto by market cap, was also off, declining approximately 11% over the same period, to roughly $2,050.

The charts were even darker red and included AVAX, SOL and SAND, which recently dropped 36%, 33% and 31%, respectively. Popular meme coins SHIB and DOGE tumbled about 29% and 26%, respectively.

Equity markets shared in the misery as investors digested the latest U.S. news on inflation, which ticked slight lower in April, but remained at four-decade highs. 

The prices for groceries and other consumer goods, airline travel and service industries spiked amid rising energy costs and supply chain slowdowns exacerbated by Russia's unprovoked attack on Ukraine.

The tech-focused Nasdaq sank over 3% and the S&P 500 and Dow Jones Industrial Average each dropped over 1%. Meanwhile, gold, the traditional safe haven against risk, increased about 1%.

"Today’s market reaction to the inflation report will make it hard to attract any investor who is still on the sidelines," Moya wrote. 

"The risks on Wall Street are growing and now include a Fed policy mistake, liquidity and credit risks, and growth concerns."

He added that bitcoin "remains very vulnerable to further selling pressure and could see further technical selling if the $28,500 level breaks."

LUNA and UST, the token and stablecoin of Singapore-based Terraform Labs, continued spiraling as UST’s key design imploded and trader sentiment around LUNA plummeted.

The impact wasn’t limited to niche regions of the internet either, as suicide helplines trended on community forums centered on Terra.

UST, a stablecoin pegged to U.S. dollars, fell to as low as 28 cents on Wednesday despite being backed by the likes of big-name crypto venture funds such as Three Arrows Capital and the Luna Foundation Guard (LFG).

The de-pegging, however, was unsurprising. Several algorithmic stablecoins have mostly failed over the past two years and none have thrived. been issued in the past two years. Most have failed, some have survived and none have thrived.

Examples include Iron Finance and its TITAN tokens, Basis Cash, Empty Set Dollar, Dynamic Set Dollar and many more. These equated to millions of dollars in losses for investors.

Algorithmic stablecoins like UST are backed by a basket of assets, such as LUNA and bitcoin (BTC), without depending on any centralized third party to hold those assets. 

This is unlike tether and USD coin, whose parent firms claim to hold actual dollars in back accounts to sufficiently back the values of USDT and USDC, respectively.

Tokens such as UST depend on LUNA to maintain a price of $1 using a set of on-chain mint and burn mechanics. 

Traders can always swap $1 worth of UST for $1 worth of LUNA and vice versa – with LUNA’s growing value serving as a shock absorber for UST's price.

However, the mechanism of algorithmically-governed stablecoins like UST makes them susceptible to the colloquial bank run.

As an example, consider Terra’s LUNA and UST tokens. A sudden fall in LUNA prices affects UST's entire stabilizing mechanism because users can no longer redeem their $1 of UST for $1 of LUNA. 

This creates a downward spiral as falling UST prices affect sentiment around LUNA, and a LUNA sell-off leads to lower UST prices.

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