One type of cryptocurrency, a so-called stablecoin, is meant to keep its value at $ 1. But on Monday, the third-biggest stablecoin, TerraUSD, fell as low as 89 cents, causing a flood of investors to sell their holdings.
Stablecoins get their name from their being tied to the value of government-issued currencies, such as the dollar. These $ 1 pegs are usually backed by Treasurys, cash and other dollar debt that is easily sold in times of market stress.
More than $ 18 billion was invested in TerraUSD as of this past weekend, making it the third-largest stablecoin, according to crypto data provider the Block. But unlike traditional stablecoins, TerraUSD is an algorithmic stablecoin. These pseudo dollars aren’t necessarily backed by any assets at all, instead relying on financial engineering to maintain their link to the dollar.
Such designs have been criticized by market observers as risky because they rely on traders to push the value back to $ 1 rather than having assets that continuously support the price. If traders aren’t willing to buy them, coins can go into a so-called death spiral. TerraUSD has mostly maintained its dollar peg, but it has been broken in bouts of heavy volatility.
In TerraUSD’s case, if its price falls below $ 1, traders can “burn” the coin — or permanently remove it from circulation — in exchange for $ 1 worth of new units of another cryptocurrency called Luna. That reduces the supply of TerraUSD and raises its price. Conversely, if TerraUSD climbs above $ 1, traders can burn Luna and create new TerraUSD. That increases the supply of the stablecoin and lowers its price back toward 1.
The break in the peg, which began over the weekend, started with a series of large withdrawals of TerraUSD from Anchor Protocol, a sort of decentralized bank for crypto investors, said Ilan Solot, a partner at crypto hedge fund Tagus Capital LLP. Anchor Protocol — which is built on the technology of the same Terra blockchain network that TerraUSD is based on — had been a major factor in the growth of the stablecoin in recent months, by allowing crypto investors to earn returns of nearly 20% annually by lending out their TerraUSD holdings.
In tandem with the big withdrawals, TerraUSD was also being sold for other stablecoins backed by traditional assets through various liquidity pools that contribute to the stability of the peg, as well as through cryptocurrency exchanges.
The dislocation of TerraUSD from its peg caused some traders to panic and sell. To reinstate the peg, others began selling ether and buying TerraUSD, weighing on the dollar value of the second-largest cryptocurrency by market value. Some traders also sold bitcoin over the weekend in anticipation that the platform would need to sell its bitcoin reserves to support the peg, Mr. Solot said. Bitcoin fell 10% Monday to about, 31,076 amid a broad sellloff in the crypto markets.
TerraUSD in Monday evening trading was at about 93 cents, after touching the low of 89 cents earlier, according to CoinMarketCap. Panic selling also hit the related Luna cryptocurrency, which has dropped 30% since Sunday, wiping out $ 5.6 billion of market value, CoinMarketCap data show.
The Luna Foundation Guard, a nonprofit supporting Terra, said it voted to support TerraUSD by lending 750 million of bitcoin to trading firms to protect the stablecoin’s peg and lending out an additional 750 million in TerraUSD to buy more bitcoin.
Do Kwon, the South Korean developer behind TerraUSD, co-founded the Luna Foundation Guard and said this year it would run a huge bitcoin reserve fund that would spend heavily if needed to protect the stablecoin’s peg. His company, Terraform Labs, has donated several billions of dollars of crypto to the nonprofit.
“Deploying more capital — steady lads,” Mr. Kwon tweeted on Monday.
The selloff might have stemmed from someone or a group of people trying to break the peg, Mr. Solot of Tagus Capital said. Regardless of the cause, he doesn’t expect TerraUSD to return to $ 1 immediately since a queue of sell orders are still waiting to be processed.
“I don’t think this peg is going to come back soon,” he said. “There’s so much [TerraUSD] Still to come out of the system, and that’s going to continue putting pressure on the peg. “
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