The cryptocurrency world was rocked last week. The cryptocurrency market lost $500 Billion (Yes with a B). The popular cryptocurrency Terra Luna lost 99% of its value, dragging down a so-called “stablecoin” with it. The “stablecoin” cryptocurrency TerraUSD, (UST) fell from a high of $118.00 (in April 2022), to $0.09 on Thursday (05/12/2022).
TerraUSD is an algorithmic stablecoin developed by Terraform Labs out of Singapore. An algorithmic stablecoin means it does not have reserves (fiat currencies or other highly liquid assets). Instead, its value was supposed to be maintained by a complex mechanism. Its value comes from swapping TerraUSD coins with a free-floating cryptocurrency called Luna to control supply.
What is a stablecoin
The goal of a stablecoin is to offer investors a safe harbor to avoid the fluctuations in other cryptocurrencies like Bitcoin and Ether. They are supposed to hold a constant value, no matter market conditions. Recently, stablecoins have been used in international trade and as a way to avoid capital controls, according to experts. The theory behind stablecoins is try to ensure they remain in parity (peg) with certain assets. The assets can be the U.S. dollar – with one token equaling $1, for example. However that did not work for TerraUSD (UST), 
The core theory to maintain its peg is as old as the dismal science. They create supply and demand. Whenever 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. UST was also partly collateralized by billions of dollars’ worth of bitcoin (not highly liquid).
The “algorithmic stablecoin” tanked the broader cryptocurrency market when it fell well below its theoretically fixed peg of 1 to 1 to the U.S. dollar. After losing its peg, UST traded as low as 13 cents on Friday. Luna, its sister cryptocurrency, became nearly worthless overnight after trading for $80 a week earlier. As investors saw the stablecoin dropping, they rushed to withdraw their money (an online bank run). Major crypto exchanges ultimately delisted both Luna and UST to protect consumers.
The collapse sent a tsunami thru the cryptocurrency markets and spooked investors. Bank of America Research says it was the worst implosion since May 2021. It measures up to both the 2008 financial crisis and the dotcom crash in 2000. The entire cryptocurrency market now has a market capitalization of less than half of the $2.9 trillion it was worth in November 2021.
Bitcoin, which makes up around 44% of the crypto market, price dropped to a 90-day low of $26,350 per bitcoin. As UST fell BTC lost more than 56% from its November high of $68,990.90.
Coinbase (COIN), the only major publicly traded cryptocurrency exchange, also fanned the fire. In midst of the cryptocurrency implosion, COIN warned customers that their cryptocurrency holdings could be at risk if Coinbase goes bankrupt. CEO Brian Armstrong said Coinbase issued the warning in order to comply with updated SEC guidance.
Ethereum (ETH), the second-largest cryptocurrency, dropped to a third from a November 2021 high of $4,812.09 to $1,748.30 during the UST meltdown.
Smaller cryptocurrencies were not immune to the cryptocurerncy implosion.
- Monero (XMR) lost a third of its value during the implosion. It fell to a low of $119.30 from from a high of $457.15 set earlier in the week.
Dogecoin (DOGE) Elon Musk’s pet cryptocurrency fell from a high of $0.69 per coin to a low of $0.08 per coin. During the cryptocurrency meltdown It lost 88% of its value.- SHIBA INU (SHIB) fell to a low of $0.00001079/coin. It’s previous high set in May 2021 was $0.00008/coin.It lost nearly 93% of its record value.
So what happened?
Cryptocurrencies were once viewed as newest hedge against interest rates and inflation. However experience has proved they are far more correlated to overall markets than early adopters hoped. Crypto proponents tell us that cryptocurrencies are an uncorrelated assets. In other words, it should float freely, divorced from the rest of the market. But that is not true. Because crypto moves much more like a tech stock than it does an inflation hedge. When tech stocks tank, so do digital assets. Garrick Hileman research chief at Blockchain.com and visiting fellow at the London School of Economics said, “We see more overlap in ownership than we ever have, this kind of convergence between Wall Street and crypto.”
Faulty cryptocurrency systems
The reason TerraUSD in particular went down so much is that the Terra blockchain network automatically shut down. Terraform Labs explained, the price of Luna tokens had dropped so low that it was unable to “prevent governance attacks.” That shutdown for a time prevented transactions in the algorithmic stablecoin. The company tweeted that the move was necessary to allow it “come up with a plan to reconstitute it.” Additionally, the company’s chat board posted a notice saying it had been “locked down so new people can’t come in and spread fear, uncertainty, doubt and misinformation.“
Elon Musk flip flops on cryptocurrencies
The cryptocurrency implosion follows a recent crash brought on by social media influencers. Elon Musk and Tesla made a U-turn on accepting Bitcoin as payment for its products.
Telsa bought $1.5b of Bitcoin shares, which sent the market price of both the crypto and TSLA soaring. The decision by Tesla to not accept cryptocurrency was seen by some as a ding on the credibility of cryptocurrency to compete against physical currencies. Another problem is Elon Musk’s support of Dogecoin. Dogecoin is so unstable it was off 88% from its high during the cryptocurrency implosion.
China outlaws cryptocurrency
China continues clamping down on non-Chinese cryptocurrencies. Recently the government blocked initial coin offerings, and warned against speculative trading. Additionally, China ordered Bitcoin mining in its Sichuan province to shut down completely and told banks to stop supporting crypto transactions, in a latest wave of restrictions on cryptos.
Additionally the country’s central bank, People’s Bank of China, has effectively banned digital coins after announcing all transactions of cryptocurrencies are illegal. This forced Chinese crypto miners to move to other jurisdictions that were more miner-friendly driving up coin costs.”
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As we have seen a bad-timing and a number of missteps laid on top of a tumbling stock markets and war in the Ukraine caused many users to lose faith in UST and make an old fashioned bank-run on the cybercurrecny.
The Federal Reserve warned that stablecoins are vulnerable to investor runs because they are backed by assets that can lose value or become illiquid in times of market stress. A run on the stablecoin could therefore spill over into the traditional financial system by creating stress on these underlying assets, it said and we saw.
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Ralph Bach has been in IT long enough to know better and has blogged from his Bach Seat about IT, careers, and anything else that catches his attention since 2005. You can follow him on LinkedIn, Facebook, and Twitter. Email the Bach Seat here.
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