March 22, 2023

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stablecoin terra tether bitcoin crypto crisis

What Caused the Current Crypto Meltdown?

Almost $1 trillion in value has been lost from the crypto market in the last month. 

Bitcoin’s freefall to below $30,000 from its November 2021 all-time high of over $68,000 precipitated a collapse of the crypto market last week. Affected digital currencies included blue-chip coins such as Ethereum, as well as stablecoins. 

According to Bank of America, the fall of speculative tech stocks and crypto since the start of the year now equals historic market collapses such as the dotcom crash and the financial crisis. 

What precipitated the collapse and what did it reveal about the stability of so-called “stablecoins”? 

Cryptocurrencies have been a port in the storm for investors looking to find safe harbor from the vicissitudes of the stock market in the past. Now, for the first time, Bitcoin and other digital currencies appear to be lining up with the movements of traditional markets. 

The addition of retail investors and the increasing integration of existing financial infrastructure that allows institutional investors to join in crypto markets have contributed to the gradual syncing of stock prices– particularly tech stocks – and those of crypto. 

“With cryptocurrency fast gaining legitimacy in the financial world and rising in popularity among hedge funds, we should expect to see cryptocurrencies increasingly mimic the movements of global stock markets,” Michael Kamerman, chief executive of trading platform Killing, told The Independent.

Global and national trends such as rising interest rates, inflation, and supply chain issues due to COVID-19 and the war Ukraine are being reflected in the previously impenetrable crypto market as a result of the integration.

The Rise and Fall of Stablecoins

Stablecoins like Tether and Terra have been some of the hardest hit by the crypto collapse. Stablecoins tie their value to a fiat currency or other commodity such as gold. They aim to provide an alternative to the high volatility of the most popular cryptocurrencies including Bitcoin, but recent developments have tested — and ultimately broken — that theory.

Stablecoins such as USDC and Tether get their stability from large reserves and are supposed to keep enough liquid assets on hand to cover all of the coins in circulation.

Terra is a  new algorithmic stablecoin, also known as a non-collateralized stablecoin, that uses smart contracts that stabilize the currency so it hovers around $1 per coin. 

The novel approach to cryptocurrency was tested to its limit during the recent crisis when investors became concerned about their assets. The algorithm could not sustain the $1 peg due to a mass sell-off, and the stablecoin essentially collapsed. 

By the end of Thursday, the market capitalization of the project had fallen from $41 billion to $6.6 million, “the largest destruction of wealth … in a single project in crypto’s history,” according to Charles Hayter of the analytics firm CryptoCompare. By Monday terra was trading at just 11 cents, according to The Guardian

The mainstream integration of cryptocurrencies and the rise of stablecoin blockchains that seek to tie their value to the dollar or other commodities created the perfect storm. Now investors have to decide whether to jump ship, weather the waves, or double down.

By Aron Vaughan

By Aron Vaughan

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