DeFi fo fum, I smell the blood of investor shun!
Algorithmic stablecoin TerraUSD (UST) crashed in value to 29 cents on 11 May, recovering to 47 cents at the time of writing.
As a coin theoretically pegged to the US dollar, UST’s crash to just 29 percent of its putative value and its recovery to less than half is a troubling moment for alternative, decentralised finance (DeFi).
However, the fall of Terra’s twin digital token, Luna – a more traditional cryptocurrency – has been spectacular: from a one-year high of $119.18, Luna is worth $0.064, at the time of writing on 12 May.
Some commentators have described the fall as the Lehman Brothers moment for DeFi, a clumsy metaphor given that neither currency has actually failed and may rally in value. It is more the case that the core concept of Terra has been exposed as built on little more than faith, hope, and promises.
The collapse occurred in a torrid weak for alternative finance and cryptocurrencies, with Bitcoin, Ethereum, Cardano, BNB, and other coins all experiencing steep losses. Forbes described events as a trillion-dollar meltdown in the DeFi market, reversing most of the market’s gains since 2020.
But what happened with the Terra coins?
Unlike stablecoins that are directly linked to a fiat currency or physical asset (forging a link between the digital and analogue worlds), the two Terra coins exist in a symbiotic, entirely virtual relationship that is designed to keep UST pegged at $1, and to keep the value of Luna relatively stable.
In short, it is a kind of algorithmic balancing act, allowing investors to switch their holdings from one to the other – akin to a tightrope walker’s pole that enables balance and steady progress forward. But only in theory.
That the concept is flawed is plain to see: the pole has snapped and billions of real-world dollars, the kind that people use to buy pizzas or Maseratis, are now being poured into joining it together again to restore the promised stability.
As ever with the blockchain-based world of cryptocurrencies, stablecoins, and other digital tokens, one of the underlying problems is these systems’ relationship with the real world: of physics, energy, physical goods, assets, and old-fashioned money.
After all, such a link must exist somewhere; without it, any coin is purely an exercise in networked hype or hope. It has no intrinsic value.
Just as Bitcoin and some other coins use proof-of-work blockchains that consume vast amounts of energy that make the cost-per-watt of mining a critical concern – at a time when energy bills are soaring – so other coins are also linked to things that have a real-world cost.
In the case of the Terra-ble twins, it transpired that one reason for the collapse was that roughly three-quarters of the UST in circulation was on the Anchor platform, a decentralised lending and borrowing protocol – itself built on the Terra chain.
Anchor promises investors a stable interest rate of up to 19.5 percent. In other words, people were incentivised to be loyal to UST and Luna not because of those coins’ own attractiveness, but because Anchor itself promised high yields and a hedge against market volatility.
A network of promises within promises within promises that have attracted the bane of the DeFi world: mercenary capital. The problem with merc capital is it is loyal to no one but itself, and will take flight at the first sign of trouble. Which is exactly what happened.
Meanwhile, all those promises of stability and the safety of compound interest have proved to be meaningless – at least, when measured in the real time of crypto valuations and confidence.
The total value locked (TVL) on the Anchor platform is currently just $1.28 billion, with its price declining from a high of $17.1 on 5 May to just under $2.24 at the time of writing. So, guess what? Real money is draining out of the platform by the bucketload, and taking the virtual kind with it.
It is worth pointing out that high-stakes gamblers have no philosophical interest in establishing an alternative ‘people’s financial system’; they just want to make a quick buck.
Yet with so much of the traditional financial system rigged against ordinary people these days (as many of us struggle to balance household costs) gamblers can’t be blamed for that.
Assuming that the gamblers are ordinary people rather than passing billionaires who can use social platforms to tweet up their wealth to millions of followers, of course.