The collapse of Terra, the failure of Tether: what is happening in the crypto market and how the current crisis differs from previous ones

The new fall of bitcoin - and with it other cryptocurrencies - may be different from the previous ones, when the recovery came quickly enough. This time, with the collapse of the stablecoin TerraUSD (UST), one of the foundations of the cryptocurrency ecosystem is in question - and one of the few remaining channels for withdrawing funds from Russia to abroad.

What's happening

On Thursday, May 12th, bitcoin peaked 10% to $25,500 levels. Although it then recovered to $27,500, this is still the lowest level since December 2020. The fall of bitcoin over the past seven days was the deepest since the pandemic March 2020. Ethereum and many other cryptocurrencies (for example, Avalanche and Solana) have similar dynamics, and in just the past day, the wide crypto market has lost $200 billion in capitalization.

The Wall Street Journal explains the situation by two factors. Firstly, this is the sale of risky assets by investment funds that have entered the crypt in the face of persistently high inflation in the United States, pandemic risks and the conflict in Ukraine. Secondly, this is the ongoing collapse of TerraUSD, the third largest stablecoin in terms of capitalization. By 13:00 on Thursday, one UST was worth $0.51 after falling to $0.3 the day before.

Perhaps the most worrisome thing about what is happening is the departure from parity to the dollar of the main stablecoin Tether. Tether is allegedly backed by $83 billion in real assets, but fell briefly to 97 cents today despite Tether CEO Paolo Ardoino's announcement that the one-for-one exchange of tokens for dollars continues. Some less powerful alternative stablecoins (such as USD Coin) are above parity. What was the matter is not yet clear, the Financial Times bluntly writes , except for conspiracies about the collusion of large funds with the authorities in order to collapse the crypto market and introduce strict regulation.

Why UST collapsed

The first signs of the collapse of a crypto asset with a capitalization of $18 billion appeared over the weekend. The parity (“peg”) of UST against the dollar has faltered due to a series of large withdrawals to other cryptocurrencies through the Anchor Protocol, an analogue of a decentralized bank. At the level of market rumors, BlackRock and Citadel Securities were called the culprits, but both investment funds denied their involvement .

The Fed's report on financial stability added fuel to the fire, directly pointing to the instability of stablecoins to a real stress test. One way or another, what is happening has worried traders, who on Tuesday drove UST by $0.8, and on Wednesday - by $0.3. US Treasury Secretary Janet Yellen, in this regard, reiterated that the sector needs to be introduced into the framework - preferably before the end of the year.

On Thursday, the situation did not fundamentally change, despite the promise of the UST developer - the South Korean Terraform Labs represented by the founder Do Kwon - to support the cryptocurrency with $1.5 billion raised, including in other cryptoassets.

Unlike Tether, which is backed by real assets, UST's stabilization mechanism is purely algorithmic. What it is is well described by Bloomberg. The bottom line is that TerraUSD has a "paired" cryptocurrency - Luna. If TerraUSD falls below parity with the dollar, the "surplus" tokens are automatically "burned" by being exchanged for the additional issue of Luna, and vice versa.

The problem here is that Luna must always have at least some value, and the exchange means something more than "selling a figure in an Excel spreadsheet for a million dollars." At one time, bitcoin was able to become an indispensable means of trade and transactions and get rid of the “pyramid” birthmark. For a stablecoin, widespread adoption would mean the impossibility of attacking parity, and then the cryptocurrency could be backed by assets up to fiat currencies and US government bonds. In reality, Luna has lost 99% of its value over the past day and is now trading at 6 cents, cheaper than dogecoin, writes WSJ.

The backing of Tether, another type of stablecoin, also raises questions — the company only disclosed its rough reserve structure last fall after a trial and a fine. 28% of its security was US government bonds, another 10% - currency and deposits. But the rest was mostly corporate debt, and it is possible that among the assets were short-term debts of large Chinese companies.

Why is it important

UST is not the most popular stablecoin on the Russian market: the top 3 were Tether, USD Coin and Binance USD. But this is a completely decentralized currency that does not depend on centralized exchanges - the same Binance recently restricted the access of Russians due to EU sanctions.

Why such stablecoins are needed, the Russians felt for themselves, who were forced to contact bitcoin after the start of the “special operation”. Since the end of March, the main cryptocurrency has fallen in price by more than 40%. According to The Block, the ruble/Tether peaked in early March (about $200 million from March 1 to March 10). The volume of trading in the ruble/bitcoin pair on the same dates amounted to about $130 million.

UST was losing in volume to Tether, but was still very popular with Russian users, the current crypto investor told The Bell. It was used by those who did not want to mess with centralized stablecoins. According to the investor, in recent months, many Russians who use cryptocurrencies to withdraw money abroad have invested in UST to remove the risk of blocking. “True, now their assets have depreciated,” the investor laments. Over the past 24 hours, he himself has lost more than a million rubles due to the fall of the cryptocurrency market, many of his friends have lost tens and hundreds of thousands of dollars.

He believes that the main consequence of the fall of UST is the fact that another major algorithmic stablecoin is unlikely to appear in the coming years. And this means that crypto investors will not have the opportunity to bypass the attention of regulators with which centralized cryptocurrencies will be forced to cooperate.

On a global scale, the capitalization of all stablecoins exceeds $100 billion, and they are increasingly being used not to protect savings, but to buy other cryptocurrencies. Therefore, the loss of confidence in stablecoins with the collapse of UST represents “an existential test for the entire cryptocurrency system,” writes the WSJ. “It’s kind of like the collapse of Bear Stearns made investors wonder if Lehman is going to fall,” well-known crypto investor Aaron Brown told Bloomberg.

It is not worth overestimating the impact of the UST case on the market as a whole, Viktor Pershikov, a leading analyst at 8848 Invest, is sure. “Market participants pay too much attention to this situation. Even if we assume that this is a scam, then, in fact, nothing extremely bad for the crypto market has happened, ”the analyst is sure. Crypto projects have already lost much larger amounts, but the market continued to exist. In addition to the UST, the situation is affected by the tightening of the policies of the world's central banks, the fall of the classical stock markets and the correction relative to the growth of the last year. “I think that by the end of the year, prices for the most capitalized crypto assets will recover,” says Pershikov.