The significance of the crash of stablecoin terraUSD


Stablecoin terraUSD (UST) crashed from its $1 value this week, while its sister token Terra (Luna) slumped more than 95% in the past five days. Mint looks at the ramifications the crash in these tokens can have on the overall crypto market.

What is terraUSD stablecoin?

A stablecoin is linked to an underlying asset such as the US dollar or to a precious metal such as gold. TerraUSD is a decentralized algorithmic stablecoin. This means that rather than being backed by an asset, UST uses complex codes to create new coins or destroy old ones to maintain a steady price at $1. All stablecoins have a governance token, which provides the stability. In the case of UST, it is Luna, which explains the correlation between the two tokens. The theory that stablecoins are not affected by price volatility drives the attraction for these crypto assets.

Why did the crypto token crash?

According to reports, big investors started dumping UST worth millions of dollars over the weekend, causing the coin to drop below $1. The logic behind stablecoins is that investors will bring in money or move out of the governance token, which will cause the rebalancing of the stablecoin itself. However, combined with the recent fall in the overall crypto market and the dumping of UST, the coin failed to stabilize and hit a low $0.60 on Tuesday. The creators of Terra attempted to stabilize the token by bringing in money from outside, but terraUSD further collapsed to $0.30 level on Wednesday.

Unstable stablecoin

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Unstable stablecoin

Can it damage the overall crypto market?

The Luna Foundation Guard, which backs the Terra blockchain, has deployed $1.5 billion in bitcoin and UST loans. Crypto experts suggest the foundation might be forced to sell a large portion of its bitcoin to prop up UST. The nervousness was evident as bitcoin slumped to below $30,000. The slump in terraUSD also raises questions over the stablecoin ecosystem.

Will it delay recovery in crypto assets?

Amid the risk off sentiment in the overall financial markets because of the Russia-Ukraine war, rising inflation, and interest rate hikes, the market capitalization of the crypto market has fallen below $1.5 trillion against a high of more than $3 trillion. The damage is largely restricted to UST. Crypto market expert Ajeet Khurana said the losses may have been curtailed for now, unless we see a different algorithmic coin fall. However, this is a huge warning and will at least for the time being reduce people’s confidence in the crypto system.

Will this lead to tighter crypto regulations?

US treasury secretary Janet Yellen reiterated calls to authorize the regulation of stablecoins, after a major fall in terraUSD, which was till a few days ago the fourth-largest stablecoin and 10th-largest cryptocurrency by market value. According to a recent report by Fitch Ratings, the rapid growth of stablecoin issuance could have implications for the functioning of short-term credit markets and authorities are, however, unlikely to intervene to save stablecoins in the event of a disruptive event, partly because of a moral hazard.

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