Terra Luna – is this the end for cryptos?
In early May, the ‘algorithmic stablecoin’ Terra USD (UST) became unpegged. What does that mean? Well, an algorithmic stablecoin is tied to something. It holds its value based on an algorithm, which balances it with a partner coin. In this case, UST is partnered with the Terra (LUNA) cryptocurrency, which in turn is linked to the US dollar. When a UST coin is created, the equivalent of $1 in Luna is removed from circulation, and vice versa. This maintains the peg. The UST had held its value against the dollar for 18 months, as designed. But on the 9th May the peg broke. Approximately $40 billion of market value was lost between UST and LUNA. Terra’s blockchain was halted several times and then LUNA and UST were delisted from multiple cryptocurrency exchanges, including Binance and Coinbase.
An old-fashioned bank run?
The shockwaves also hit the rest of the crypto space. Even the two giants, Bitcoin and Ether were pummelled, in what was effectively a ‘bank run’ due to loss of confidence. Some major Terra investors, including Mike Novogratz, the billionaire founder of crypto asset management firm Galaxy Digital, blamed the effective end of LUNA and Terra USD on the “global macro backdrop,” which has hit all risk assets this year. He highlighted the US Federal Reserve’s plan to tighten monetary policy aggressively to try and tame inflation, thereby reducing the stimulus which has done so much to boost asset prices since 2009, when Bitcoin first appeared.
Just a techy Ponzi scheme
Since the beginning of this year, global markets have been battered by inflation, central bank rate hikes, and geopolitical turmoil. This latest crypto shock has been the icing on the cake, wiping around $1 trillion off the sector in a month. For critics of the crypto world such as hedge fund manager Bill Ackman, the latest crash was simply an inevitability. In his view, the Terra Luna debacle is just one more pothole on the road to cryptos being worthless. As far as many investors are concerned, cryptos are simply a collection of elaborate ‘Ponzi Schemes’.
Wipe out
Events like this affect the whole crypto market. Investors are forced out of their existing positions, causing a downward price spiral. These ‘rushes for the exits’ can be seen everywhere. But they are especially dangerous in the exceedingly high-volatile crypto-world. Those who were fully invested in the troubled crypto at the heart of the problem get wiped out. Even those with diversified positions are affected, particularly if trading with leverage, or collateral linked to other financial markets. But many see these crashes as opportunities, and it’s quite possible that this will prove to be the case here. The collapse of Terra has undoubtedly led to a loss of confidence in stablecoins, which may prove permanent, or until investigators get to the core of the issue. For instance, was this bound to happen, or was maleficence involved? But we’re already seeing a recovery in the biggest cryptos with Bitcoin and Ether both modestly higher since Terra’s collapse. It’s also worth considering what an increasingly large and integrated part of the global financial system the crypto network has become.
Bigger than ever
The crypto sector is bigger than ever, with major financial institutions forced to take it seriously. This is despite its many crashes and recoveries. Whenever there is a big downside move its detractors are quick to shout: ‘I told you so’. But they go very quiet when cryptos recover, phoenix-like from the ashes. So far, every recovery has seen cryptos emerge stronger, as investor confidence builds. The crypto market may still look fragile and vulnerable to further declines. But we shouldn’t write it off. If you want to get involved, just make sure you do your homework, and be prepared for more of the same.
