The Luna/UST bubble burst last week and triggered a wider crypto market sell-off. The stablecoin’s demise also sent reverberations across major blockchains and stablecoins and we can expect this to last for the foreseeable future.
The collapse has led to increasing negative sentiment on stablecoins and DeFi in general. For retail traders, the panic caused a widespread sell-off for other stablecoins. Popular stablecoin USDT briefly experienced a depegging, even dropping to around $0.95 USD at one point. Fantom’s stablecoin DEI has also depegged, and is trading at $0.60 at time of writing.
From this point onward, stablecoin mechanisms will be considered a risk and issuers may be more closely scrutinized. Looking briefly at other prominent stablecoins, people may find fault with USDC for being centralized, USDD for having a controversial founder, and USN for being new.
It’s not only stablecoins. Last week, staking protocol Lido warned that the swap rate between ETH and stETH on its platform has deviated from its peg amid market turbulence — as holders attempted to flee Terra’s Anchor protocol via cashing out staked Ether.
Credit: @DeFi_Made_Here / Twitter
In general, plummeting prices often send spooked traders releasing risky assets like crypto for lower risk assets. It’s no wonder the market is so bearish now.
More importantly, the crash has allowed for crypto regulators to adopt harsher positions. US SEC Chair Gary Gensler accused crypto platforms of “trading against their customers”. SEC Commissioner Hester Peirce signalled that stricter rules around stablecoins are upcoming. South Korea, which Terra founder Do Kwon is a citizen of, launched an “emergency” investigation of domestic exchanges about LUNA/UST and may call Do Kwon to a parliament hearing.
Perhaps worst is how the crash could drive many new traders back to the arms of centralized money and TradFi, erasing efforts by the crypto world to educate them about decentralized money.
What matters to stablecoins?
Simply: Whether a stablecoin can maintain its peg and whether investors trust the issuer. Unlike UST, common stablecoins like USDT, USDC or BUSD are backed by non-crypto assets like USD cash or US bonds to make sure each circulating stablecoin is pegged to 1 USD. However, issuers have never publicly shown a breakdown of their reserves.
Depegging is a serious problem affecting not only crypto but also the traditional financial system. For example, if USDT holders lose confidence in the stablecoin, they would quickly cash out USDT to fiat currencies. In order to meet this redemption demand, Tether would have to sell a large number of low-risk assets in its reserves to maintain the peg, which will hurt the wider financial system.
Investors may continue to hold and use USDT because they believe in the ability of Tether to conduct redemptions (when users redeem Tether for USD). During the recent round of USDT depegging, Tether showed reasonable redemption power and USDT regained its peg. But once this consensus is broken, the value of USDT may become unstable.
Can UST be salvaged?
Terra recently announced a proposal, Official Proposition 1164, to expand the UST base pool size and speed up burning to help UST regain its peg. On 16th May, the Luna Foundation Guard revealed its reserves and attempted sells to save UST’s peg. It also declared that it would compensate the smallest holders of UST first; details to be confirmed.
Credit: @LFG_org / Twitter
However, the fact remains that UST has not regained its peg and is trading at $0.09 at time of writing, according to CoinMarketCap. The proposal was also rejected by majority voters. There is already a lack of trust in Terra’s ability, despite Do Kwon’s assurance, to show redemption power. Coupled with factors like members of Terraform Labs’s legal team resigning, investors may find it difficult to be confident about UST’s recovery.
All things said, crypto is risky and no coin or token is too big to fail, even “stable” coins. But the crypto market is also extremely resilient. Although we may start to go through a bear market from now, it is also a good time for us to distinguish among valuable projects, which can still improve and move forward in a down market.
The views expressed in this article are the author's alone and do not necessarily represent the views of ApolloX.
Risk Reminder: Crypto and NFT trading carries a risk. All trading activities are done at your discretion and at your own risk. The information here should not be regarded as financial or investment advice from ApolloX. ApolloX will not be liable for any loss that might arise from your use of any financial product.
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