#437
The Dark Side Of The Moon
Published:
May 14, 2022
Author:
Cindy Grazer
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It is often said that crypto is on a path of speedrunning through the lessons of 100 years of modern finance (h/t Matt Levine). This week’s unwind of Terra (Luna), which was one of the largest blockchain and stablecoin ecosystems within the crypto economy, had the unfortunate hallmarks of some of the more painful financial lessons of the past century.
Much has been written this week surrounding the post mortem of the UST stablecoin; an algorithmic stablecoin built on the Terra blockchain. As a summary, unlike other popular stablecoins that are often backed and redeemable by reserve assets such as cash and US treasuries, algorithmic stablecoins such as Terra’s UST were supported by a seigniorage mechanism which allows anyone to swap 1 UST with $1 worth of LUNA tokens, and vice versa. This algorithmic model has historically been challenged and at a severe risk of destabilization when users lose confidence in the peg mechanism, and rapidly exit out of the stablecoin and don’t bid and support the associated seigniorage token. With no reserve assets to redeem, once an algorithmically fixed peg is broken, reflexivity to the downside takes over.
While a challenging stress test for the broader crypto ecosystem, the upshot of events like this week is the hope for community-wide alignment in recognizing the pitfalls in specific economic system designs and continuing to iterate and build more robust crypto incentives going forward. Fortunately for the industry, the most widely used stablecoins are indeed not algorithmic, but 1:1 asset-backed with fiat and cash equivalents, such as USD Coin and Tether. These stablecoins have a mint-and-redemption mechanism that allow centralized issuers to liquidate collateral backing the tokens should the underlying stablecoin deviate too far from their desired peg.
At its best, crypto and stablecoins have the potential to be an enormous equalizer for the world: a decentralized financial system that provides equitable financial access globally at the speed of the internet. It's still early, but the results thus far have captivated a wave of global enthusiasm across developers, investors, and financial institutions alike — who all see the bright side.
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The Dark Side Of The Moon
Terra crunch shakes foundations of crypto stablecoin complex - TerraUSD, or UST, and its related token Luna, had a long way to fall. They both recently climbed into the top 10 tokens by market value after Terra founder Do Kwon established the Luna Foundation Guard, which bought billions of dollars of Bitcoin to back it up. On Wednesday, Kwon announced measures aimed at bringing TerraUSD back to the $1 peg, which includes minting Luna at an increased pace. Read more
Stablecoins are vulnerable to runs, may heighten risks, Fed says - Designed to maintain a peg to a hard currency like the U.S. dollar, stablecoins are backed by assets that may lose value or become illiquid during stress. The U.S. central bank repeated its concerns that the tokens are therefore “vulnerable to runs” and said a lack of transparency around the assets may exacerbate those vulnerabilities. Read more
Tether declines to reveal details on $40b Treasury cache after dollar peg snaps - Tether has refused to disclose details on its $40bn hoard of US government bonds for fear of revealing its “secret sauce”, even as one of the world’s most important crypto assets comes under strain from heavy selling pressure. Read more
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