Stablecoins Terra and Tether depegged from the dollar, leaving analysts wondering if this marks a ‘Lehman’ moment for crypto

By May 12, 2022DeFi
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The collapse of the cryptocurrency "stablecoin" TerraUSD, also known as UST, is evoking fearful comparisons to the 2008 Global Financial Crisis, as some analysts wonder whether the entire crypto ecosystem could be at risk of imploding.

UST's collapse this week, when the stablecoin that is supposed to be pegged 1:1 to the U.S. dollar devalued to a low of $0.30 on Wednesday, is “sort of like [how] when Bear Stearns failed, it focused people’s attention on whether Lehman would fail”, crypto investor Aaron Brown told Bloomberg.

Brown was outlining concerns that negative sentiment caused by the collapse of one so-called stablecoin could implicate the wider crypto space. Already, there are signs of contagion in the market. Coins like Solana and Avalanche are in flux, sinking by over 25%. Even USDT, one of the world’s most widely-used stablecoins, briefly stumbled on Thursday, falling off its dollar peg and sinking to a low of $0.951 before recovering to $0.985.

The slip in USDT is more worrying than the collapse of its stablecoin peer, UST. Because USDT's dollar-peg is supposedly backed by real-world financial assets, its stumbles could have repercussions for traditional markets as well as the crypto-sphere.

“If the one-to-one pegs on the US Dollar backed instead of algorithmic (un)stable coins crack, things are going to get ugly fast and may lead to cross-margining selling in other asset classes,” writes Jeffrey Halley, senior analyst for OANDA, in an analyst note.

Terra-fied

Stablecoins like UST are a critical piece of the cryptocurrency ecosystem, providing a typically safe place for investors to park funds in between trades on much more volatile cryptocurrencies, like Bitcoin or Ether. Because stablecoins are built on blockchain technology, holding dormant funds in something like UST means investors can deploy that capital on a crypto exchange faster than if they held all their cash in a fiat currency, like the dollar.

The collapse of stablecoins is trashing that safe space.

After UST—an “algorithmic” stablecoin that used smart contracts and the systematic buying and selling of cryptocurrencies to preserve its value at $1—broke its peg over the weekend, its sister coin Luna suffered an even larger collapse, crashing to $0.11 on Thursday, losing over 99% of its value from its $85.38 peak a week ago.

(UST uses Luna to maintain its peg. When the price of UST falls below $1, traders are incentivized to "burn" their UST tokens—taking them out of circulation—in exchange for Luna. The lower supply of UST, in theory, increases the stablecoin's price back to $1 and maintains the peg.)

The collapse of both UST and Luna has increased financial strain on certain decentralized finance (DeFi) projects that use UST and Luna to sustain their operations, tapping the coins to provide liquidity or to act as capital reserves. The price of tokens on projects like Anchor Protocol and Astroport, which are both built on UST's blockchain, have plummeted by 80% since UST started to stumble off its peg, according to CoinTelegraph.

Meanwhile, efforts to stabilize the UST peg could be piling downward pressure on traditional cryptocurrencies like Bitcoin, as the Luna Foundation Guard, a non-government organization that works to protect the value of TerraUSD, dumped its Bitcoin reserves to try to save UST's peg. Bitcoin has crashed this week to an 18-month low of $26,350.

Contagion

But unlike the collapse of Lehman Brothers in 2008, which initiated a domino effect of debt defaults that led to the global financial crisis, UST's market cap may not be large enough to cause a systemwide crypto collapse. That being said, however, negative market sentiment will likely cause crypto prices to weaken further.

“Any contagion is likely to be related to negative sentiment and selling pressure, rather than as a result of any cross-chain contagion at the infrastructure level," says Lucy Gazmararian, founder of crypto venture fund Token Bay Capital.

UST's collapse “has spooked the broader crypto market and led to retail in particular selling holdings across the board,” Gazmararian adds.

That negative sentiment may already be putting pressure on other critical parts of the crypto ecosystem, like USDT, which shed its peg on Thursday, too, threatening even further distress in the cryptospace.

The collapse of the Tether peg “will take down a large chunk of the crypto ecosystem given how central Tether became to crypto flows,” wrote Anant Jatia, founder of Greenland Investment Management, on LinkedIn.

Dogecoin’s founder Billy Markus was more succinct about the potential ramifications of Tether depegging on Twitter: “If Tether dies it’s all over friends.”

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