The crash cost investors billions of dollars. The volatility further affected other cryptocurrencies, causing the price of Bitcoin to fall sharply as well. Another stablecoin, tether, fell slightly to 96 cents on Thursday before re-pegging to the dollar.
Shares of Coinbase Global, the largest U.S. cryptocurrency exchange, have fallen more than 75 percent this year. The company said on Tuesday that it was losing users and trading volume.
The cryptocurrency market has matured in recent years. It operates as a financial system parallel to major banks, and has evolved its own “bank” and “loan” functions. These characteristics have attracted more Wall Streeters to participate and make venture capital, making cryptocurrency startups a lot of money. Crypto firms use some of that money for advertising and lobbying, portraying a growing market.
However, TerraUSD’s slump has raised pressing questions about the ambitions of cryptocurrency developers to build a new form of finance. It shows that despite the hype, nascent cryptosystems are still prone to the kind of destabilizing bank runs that occur in the non-digital world.
Do Kwon, the sincere creator of TerraUSD, instructed to spend huge sums of money trying to save his project. On Twitter, he tried to unite his followers.
“Terra’s return to normalcy will be a sight to behold,” he wrote on Wednesday morning, when his stablecoin was trading at half its expected value. “We’re here to stay. We’re going to get on with our business.”
Do Kwon, CEO of Terraform Labs in Seoul
“Stablecoins” are the backbone of the cryptocurrency financial system. While the followers of cryptocurrencies still need to keep in touch with traditional financial currencies endorsed by the government, as in the traditional financial system, paying rent, buying cars, paying bills. But they just want to trade and invest in the world of cryptocurrencies, not dollars, euros or pounds. Thus, stablecoins act as a reserve currency, an asset with a recognized value.
Stablecoins are used by both professional traders and individual investors, having invested about $180 billion in them as of Tuesday. Traders can sell bitcoin to TerraUSD and then use TerraUSD to buy ether, another cryptocurrency, without having to touch dollars or bank accounts.
Crypto firms are trying to convince Congress that stablecoins are a safe place for investors to invest. But the collapse of TerraUSD has shaken that assumption, and the idea that there might be any safe place in crypto.
Stablecoins try to solve a conundrum: how can something remain stable in a volatile financial system?
Some stablecoins try to do this by holding safe assets like Treasury bills in a kind of reserve account: For every stablecoin created, $1 of Treasury bills are deposited into the account. Redeem the stablecoin and $1 in Treasury bills will be withdrawn from the account.
TerraUSD has a more sophisticated approach. This is an algorithmic stabilization that relies on financial engineering to maintain a link to the dollar. Many cryptocurrency traders believed in this technique, and TerraUSD’s popularity soared. However, even though TerraUSD had ballooned to over $18 billion, it collapsed within days.
The catalyst that started over the weekend and snowballed Monday was a series of large withdrawals from Anchor Protocol, traders said. Anchor Protocol is a crypto bank created by the developers of Kwon’s company Terraform Labs. These platforms allow stablecoin investors to earn interest by lending their coins.
Over the past year, Anchor has sparked interest in TerraUSD by offering high returns of almost 20% on TerraUSD deposits. That’s far higher than the interest on deposits in U.S. dollar accounts at traditional banks, and higher than what crypto investors get from other, more traditional stablecoin loans.
Anchor, like other crypto lending protocols, lends TerraUSD to borrowers in need. Critics, including cryptocurrency investors who attacked Kwon on social media, question whether such yields are sustainable. Still, investors had deposited more than $14 billion in Anchor as of late last week, according to the platform’s website.
But large trades over the weekend saw TerraUSD start to depreciate from $1. This instability prompted Anchor’s investors to sell TerraUSD. This in turn caused more investors to withdraw from Anchor, creating a knock-on effect of more withdrawals and more selling. As of Thursday, Anchor’s TerraUSD deposits fell to about $2 billion, down 86% from its peak, the protocol’s website shows.
“There was a bank run,” said Michael Boroughs, managing partner at crypto hedge fund firm Fortis Digital Value LLC.
“Once people lose confidence, which we’ve seen before in money market funds and commercial paper trading, they race to get out,” said Joe Abate, a research analyst at Barclays.
The TerraUSD crisis was a blow to the Stanford graduate Kwon’s reputation. Kwon worked in cryptography beforeappleCompany (Apple Inc.) andMicrosoftcompany (Microsoft Corp.). He is outspoken on social media, often attacking critics in the crypto community.
Trouble with TerraUSD could cast a shadow of suspicion on all stablecoins, or at least turn customers to its competitors.
Treasurer Janet Yellen told Senate lawmakers on Tuesday that TerraUSD’s slump fueled the administration’s concerns that stablecoins, which include both traditional currency-backed and algorithm-backed technological means, could be stomped on by investors and require a regulatory framework.
Martin Hiesboeck, head of blockchain and crypto research at digital money platform Support, said many investors rushing to trade TerraUSD may not even know what they are doing.
“You can have a bunch of developers write an algorithm and they themselves probably know 100 percent how it works,” Heathbock said, “but the average investor doesn’t read code. They don’t read the fine print.”