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Stablecoin terraUSD (UST) crashed on May 10 and is down 54% to $0.44 on the morning of May 11, prompting regulators to renew calls for cryptocurrency legislation.
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Stablecoins are cryptocurrencies that aim to remain stable and have low volatility. They can be linked to a currency or a commodity, such as gold.
Terra, an algorithmic stablecoin, is pegged to the US dollar and can be used in conjunction with LUNA, Terra’s non-stablecoin cryptocurrency, or as a standalone token, according to CoinMarketCap. It is also the 18th largest cryptocurrency by market capitalization.
“Stablecoins are only valuable to users if they maintain their price link. The Terra protocol uses the basic market forces of supply and demand to maintain Terra’s price. When the demand for Terra is high and the supply is limited, the price of Terra rises. When the demand for Terra is low and the supply is too great, the price of Terra falls. The protocol ensures that supply and demand of Terra are always in balance, which leads to a stable price,” according to Terra’s website.
The Wall Street Journal explained that terraUSD is structured differently from other major stablecoins, as it relies on financial engineering rather than hard assets — such as cash — to maintain its peg to the dollar. In turn, critics say this makes it riskier because traders may not always respond as expected to the built-in incentives, according to The Wall Street Journal.
In a financial stability report released on May 9, the Federal Reserve said the total value of stablecoins grew rapidly over the past year to more than $180 billion as of March 2022. “The stablecoin sector remained highly concentrated, with the three largest stablecoins issuers — Tether, USD Coin and Binance USD — which make up more than 80% of the total market value,” the report said.
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Treasury Secretary Janet Yellen spoke at a Senate Banking Committee hearing on May 10 about stablecoins and the UST crash.
†[With stablecoins,] we see risks that could threaten financial stability — risks associated with a payment system and its integrity and risks associated with increased concentration if stablecoins are issued by companies that already have significant market power,” Yellen said according to Coindesk. definitely big risks here.”
She added that the risks are real-time and said UST had been on a run and had fallen in value. “I think this just illustrates that this is a fast-growing product and there are risks to financial stability, and we need an appropriate framework.”
Anto Paroian, chief operating officer at cryptocurrency and digital asset hedge fund ARK36, told GOBankingRates that UST losing its peg will be seen as one of the defining moments of the current cryptocurrency market cycle.
“Unfortunately, the impact of this situation goes beyond the material losses Luna investors have suffered,” he said. “The de-pegging is likely to result in significant regulatory risk – if not for the entire crypto space, then certainly for the stablecoins market. Secretary Janet Yellen has already highlighted the Luna situation at a meeting of the Senate Banking Committee, calling for comprehensive regulation of stable currencies by the end of the year. Of course, regulation is a net positive for the crypto space in the long run, but if stablecoin issuers are regulated as strictly as banks, it could stifle one of the most innovative, thriving and important sectors of the crypto market.
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Paroian added that the crash will also revive the debate over whether a truly decentralized, algorithmic stablecoin is possible or even desirable.
“So far, the UST situation has shown us that potential benefits may not outweigh the risks to the entire crypto space. DeFi users should also keep in mind that an 18-19% return on a DeFi savings protocol that uses a decentralized stablecoin does not come without significant risk,” he said.
In a May 11 Twitter thread, Terra founder Do Kwon announced his plan to “re-peg” UST, acknowledging that the past 72 hours have been “extremely tough on all of you.”
“The only way forward will be to absorb the stablecoin stock that wants to shut down before $UST can start to rebound. We can’t get around it,” he tweeted.
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About the author
Yael Bizouati-Kennedy is a full-time financial journalist and has written for several publications, including: Dow Jones, The Financial Times Group, Bloomberg and Business Insider. She also worked as a vice president/senior content writer for major New York City financial firms, including New York Life and MSCI. Yael is now a freelancer and most recently co-authored the book “Blockchain for Medical Research: Accelerating Trust in Healthcare”, with Dr. Sean Manion. (CRC Press, April 2020) She holds two master’s degrees, including one in journalism from New York University and one in Russian studies from Université Toulouse-Jean Jaurès, France.