Stablecoins are struggling to survive the crypto crash

These were a devastating few days for the Terra project, a week that was unforgiving for the cryptocurrency as a whole.

Over the past few days, the stable TerraUSD (UST) coin, which is designed to hold the dollar in place, has fallen sharply from the $ 1 mark and fallen to a low of less than 30 cents on May 10. In the latest update of the saga, the besieged project put its entire blockchain to stop for about two hours on Thursday, freezing users’ funds until the blockchain is restored.

This is a difficult measure, especially given the cryptocurrency’s focus on decentralization. “We’ve seen hard forks before, but this is the first time we’ve seen such a large, decentralized blockchain system decide to stop the whole thing,” said Ronghui Gu, CEO and founder of blockchain security firm CertiK.

The chaos is fueled by a steep slide she saw $ 200 billion worth of money destroyed in one day. Only bitcoin fell below $ 25,000 on the morning of May 12, a price that has not been observed since December 2020 and less than half of its peak in November 2021. Other cryptocurrencies are facing similarly difficult days, with Ethereum having lost about 20 percent of its value in just 24 hours.

Terra’s problems began on May 9, when the price of UST stablecoin began to fall sharply. Due to the way algorithmic stable coins work, this has led to a huge increase in the supply of the corresponding Luna cryptocurrency token, which is traded against the UST to balance the price.

Adding or removing Luna tokens in circulation before was enough to maintain a constant price for UST. But the size of the price slider and the corresponding amount of cut moon – supply more than three times in a few days, he sent the two related cryptocurrencies into a “death spiral” from which neither of them was able to recover.

Currently, the UST is trading at about 40 cents instead of $ 1; and the value of the Moon is almost completely erased, drops from $ 100 to about 1 cent.

UST value from May 7 to May 12.  Graphics via CoinMarketcap

UST value from May 7 to May 12.
Image: CoinMarketcap

Terra’s Nightmare Week makes it clear that stable coins, which should theoretically maintain a fixed price, could in fact be hit hard by larger movements in the cryptocurrency market – and influence those movements in turn.

Terra is not the only stable coin facing problems due to the decline of cryptocurrencies. Tether’s Stallcoin USDT, the largest in circulation, sank well below its fixed dollar to traded at 95 cents on some exchanges on Thursday morning, although the price has recovered since then. The moves were significant enough that Finance Minister Janet Yellen weighed in to reassure the House Financial Services Committee that the events did not pose a significant risk in the financial markets in general.

Still, the sudden decline is a reminder that the economy behind most stablecoins is still highly experimental. “There are stable fiat-backed coins, but people think it’s too simple – in the world of web3 and blockchain, they want to create big, new ideas and innovations,” Gu said. “That’s why there is so much research on whether it’s possible to use algorithms to generate a stable coin, but so far there are no completely convincing solutions.”

Terra’s future is uncertain, but the large volume of unredeemed Terra coins is a huge problem for the project. As more coin holders try to withdraw, they are likely to devalue the supply of Luna tokens even more, creating What BloombergMatt Levine describes it as a “spiral of death.”. ”

But Gu is still cautiously optimistic about the broader future of the stablecoins. “The collapse shows that people have overestimated what can be done with blockchain and web3 in a short period of time,” he said, “but they still underestimate what can be done in five or ten years,” he said.

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