What just happened with crypto?
The cryptocurrency world took a beating last week. Bitcoin price has fallen to levels not seen since 2020; Coinbase, the largest cryptocurrency exchange, saw its shares fall; and a top stablecoin called Terra, along with its associated cryptocurrency, Luna, crashed.
In response, crypto naysayers took to Twitter to dance on Bitcoin’s grave, and subreddits which had once been filled with celebrations of booming crypto wallets were quickly filled with people posting numbers for suicide hotlines and desperate personal stories about lost fortunes.
Part of the crypto market slowdown can be explained by the fact that cryptocurrencies now follow the stock market closely, and so the same global factors that beat the S&P 500 and the Dow Jones Industrial Average also beat bitcoin: another month of high inflation, the Federal Reserve hikes interest rates, slowing economic growth and supply chain disruptions resulting from Russia’s war on Ukraine and China’s zero COVID policy.
But it’s impossible to understand what’s going on with bitcoin without understanding the role of Terra’s collapse and what it might say (or not) about stablecoins, which are an integral part of the cryptocurrency ecosystem. .
As their name suggests, stablecoins are non-volatile digital currencies that are pegged to the dollar. This parity is ostensibly “backed by reserves such as dollars, US Treasury bonds or other traditional assets”, reported The New York Times Last week. This peg simply means that if you use a US dollar to buy a stablecoin on Monday, you can expect that on Friday that stablecoin can still be exchanged for a dollar. Using stablecoins like USDC (USD Coin) and USDT (Tether) allows investors to enter and exit cryptocurrency positions faster.
However, one popular stablecoin turned out not to be so stable: Terra, which the Time notes was “based on an algorithm that encourages traders to maintain its value”, lost almost all of its value last week after its supporting sister currency, Luna, fell to 23 cents. (More on the technical side of Terra Collapse here.) The loss of the Terra peg meant that Terra holders could not exchange their tokens for US dollars on a 1:1 basis, which is the primary function of stablecoins.
Terra losing its peg not only wiped out the wealth of Terra investors, but also led to another stablecoin, Tether, briefly losing its peg to the dollar and fall to 94.55 cents before recovering. It also likely caused many bitcoin investors to cash out lest Terra’s collapse signal a systemic problem that could spread to other parts of the crypto space.
Whether the Terra incident is a harbinger of future meltdowns depends on who you ask. “Really, we shouldn’t use the same word for all these things,” tweeted Sam Bankman-Fried, CEO of FTX, a major crypto exchange, on May 12. they need an edge if they want to justify the risk.”
The fact that Terra Holders went all-in regardless of the risk is what worries Jon Stokes, founder of Ars-Technica and a prominent Web3 watcher. “With the Terra-Luna couple, there was an ecosystem there,” he says. Reason. “It wasn’t just a stablecoin that people used on [decentralized exchanges] trade in USD and USD; there was an ecosystem of DeFi products… that were built on top of that.”
Because Terra was more than just a stablecoin, “What imploded is not just an asset, but a whole corner of web3,” Stokes says. Additionally, Terra and the associated protocol, Anchor, “had a certain amount of VC imprimatur.” There were big names and big money behind Terra, which begs the question of whether retail investors are safe following the lead of venture capitalists. and other institutional investors, who can afford greater losses.
Additionally, Stokes notes that there has always been skepticism around Terra, particularly because it was backed by volatile assets. However, Stokes says he is also skeptical of supposedly more secure stablecoins. “There’s a lot of stuff like that out there; I suspect we’ll see more implosions like this in the weeks and months to come,” he says. “I think [Tether] is vulnerable to a bank run.”
However, another way to view Terra’s collapse is a successful stress test of Tether, which quickly regained its 1:1 peg with the US Dollar. That’s what Nic Carter, general partner at Castle Island Ventures and founder of Coin Metrics, took away from the past two weeks, when Tether processed over $7 billion in redemptions. “If Tether didn’t have reserves, they couldn’t do it,” says Carter. “What this shows is that the mechanism worked as intended.” He adds that while many crypto reviewers are “blind” and “think everything is a scam,” some things really are “Ponzi-type” or “Ponzi-adjacent”; Carter says Terra qualifies.
As to why bitcoin tracks stocks so closely, Carter says it’s investors trying to manage risk in their portfolios during less-than-ideal times. “Bitcoin is a great asset to liquidate, it sells 24/7, worldwide, everywhere,” he notes.
And eventually, we could start talking about stocks following the crypto, rather than the other way around. “My guess is that… if crypto prices crash, there won’t be a ton of contagion in the rest of the financial system,” writing columnist Matt Levine at Bloomberg review. “But I think that is, at this point, debatable. Crypto has at least started to make its way into the real financial system. Some mainstream investors also own crypto; if their crypto goes down, they may have to be selling regular things.Some public companies are exposed to crypto (because they are crypto exchangesBecause they have leveraged crypto assetsetc.), so your boring old index fund might go down when the crypto goes down.” The existence of ripple effects would prove the success of crypto, in a way, Levine argues.
Despite the current volatility in the crypto space, its core promise holds true: it remains a competitor to central banks, Carter adds. “It’s very clear to me that bitcoin in particular and then stablecoins are very useful for financial and monetary freedom.”