Lehman Brothers 2.0: Crypto crash shows 'wild west' market has much to prove
The cryptocurrency market still has much to prove if it is to shake off its ‘wild west’ image after the dramatic collapse of algorithmic stablecoin TerraUSD (UST) caused systemic risk across digital assets.
Last week, UST – which is supposed to maintain a 1-to-1 peg with the US dollar –plummeted as low as $0.17, highlighting the potential dangers of stablecoins.
The move sent shockwaves through the crypto market, wiping $1trn off the asset class’s value and causing the price of luna – one of the top 10 cryptos by market cap – to crash 99.9% from over $100 to almost $0, as at 15 May.
Unlike many stablecoins that theoretically have an equivalent amount of collateral, UST – an algorithmic stablecoin – allows arbitrageurs to create and redeem in return for luna. This means if UST starts trading at $0.99, an arbitrageur can buy at this level and redeem for $1 of luna which, in theory, should stabilise the price in a process known as the burn-and-mint mechanism.
After a sell-off sent the price of UST to $0.46 last week, Terraform Labs and the Luna Foundation increased the supply of luna coins to 6.5 trillion, up from 340 million, according to 21Shares, in an attempt to maintain UST’s 1-to-1 peg with the US dollar.
With supply far outstripping demand, the price of luna collapsed to almost $0 forcing two terra ETPs, the 21Shares Terra ETP (LUNA) and the VanEck Terra ETN (VLNA), tohalt creations and redemptionslast Friday, while the Valour Terra (LUNA) ETP suspended trading entirely.
The significant risks associated with algorithmic stablecoins, in particular, have been stressed previously. In a November 2021 research paper titledBuilt to Fail: The Inherent Fragility of Algorithmic Stablecoins, Ryan Clements of the University of Calgary warned algo coins “exist in a state of perpetual vulnerability”.
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