What Stablecoin Problems Mean For Crypto Investors | Business News | Investment

Andy Rosen

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Stablecoins are supposed to be part of the cryptocurrency market that is immune to the wild swings in value that have characterized assets such as Bitcoin.

But the fall this week of one of the industry’s leading stablecoins is a reminder that many of the complex financial structures that emerged during crypto’s historic bull run have yet to be tested in lean times.

TerraUSD (known by the ticker symbol UST), one of the few stablecoins designed to maintain a market price of $1, has dropped significantly from that mark. The unwanted turbulence wiped out billions of dollars in value. This has also spilled over to other cryptocurrencies which are struggling to maintain investor confidence after falling for several months from all-time highs of last year.

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Campbell R. Harvey, professor of finance at Duke University’s Fuqua School of Business, says the situation amounts to a “painful lesson” for people who have invested in UST or its infrastructure. He says the turbulent market has helped reveal problems with the system that may not have been apparent during boom times.

“Think of it as a stress test,” he says. “If the market hadn’t fallen, it could fall next year.”

When investing in cryptocurrency or any risky asset, it can help to take a long-term view of the market. For example, if you’re investing over a 20-year time horizon, it doesn’t matter if something is worth less now than it was last week – or even last year.

However, it is also worth asking whether the factors that led to a crypto crash change your long-term view of your investment.

While the crypto market had already seen declines as US policymakers held back growth amid rising inflation, the high-profile UST flop only added to the pressure.

The fallout has been pronounced due to the increasingly interconnected nature of decentralized finance, or DeFi, a system that has grown around crypto.

What happened

  • UST developers have created another cryptocurrency, called Terra (Ticker: LUNA), to help maintain the value of the stablecoin. Ideally, UST holders can redeem it at any time for an equivalent amount of LUNA.
  • But LUNA tokens, unlike UST, have a price which is mainly determined by market conditions. It worked well when investors were confident in the value of LUNA. But as the market declined and some users dumped large amounts of UST, investors generally lost faith in the value of LUNA tokens.
  • Over the past few months, UST developers had also purchased billions of dollars worth of Bitcoin to further support the value of the stablecoin. Then, as the crisis got worse, they decided to sell some of that Bitcoinexacerbating the overall sell-off in the crypto market.

By Wednesday afternoon, the market price of LUNA had fallen below $2 from an April high above $115. Meanwhile, the UST was nowhere near regaining its “peg” to the US dollar.

And after

The creators of UST have pledged to get the system back up and running in hopes of recouping some of the market value their protocol has lost.

“Terra’s focus has always been on a long-term time horizon,” Do Kwon, founder of creator UST Terraform Labs, wrote on Twitter on Wednesday. He noted that the UST had recovered from another loss of its peg last year. “Short-term stumbles don’t define what you can accomplish. It’s how you react that matters.

Whether Kwon and his team will stage a successful comeback is unclear, but the events of this week may continue to reverberate in the crypto space. US regulators already had their eye on stablecoins, and the scrutiny could become more intense.

Harvey of Duke University notes that UST had an unusual mechanism to maintain its dollar peg algorithmically without having a large amount of collateral in place to hedge against large market swings. Some other stablecoins, such as USDC, are backed by actual cash reserves, and some have large amounts of other crypto assets to back them up.

Jon Wu, head of growth at Aztec Network, a crypto privacy protocol, says it’s possible someone could fix the issues that have arisen with UST. But he also says it’s worth considering the potential damage of a repeated event: “Is it worth the risk it presents to the whole ecosystem?” He asked.

Bill Birmingham, chief investment officer at Osprey Funds, which specializes in crypto assets, said events this week also highlight opportunities for growth in a space that is growing on the fly. “Innovation cycles in crypto are so fast,” he says. “The ability to build something, test it in the market, and see if it fails or succeeds is unlike anything we’ve seen.”

The author owned Bitcoin, LUNA and UST at the time of publication.