What is an algorithmic stablecoin? Why is Terra in the news? Here’s what investors need to know.

What happens when a “stablecoin” is not so stable? Investors are trying to make sense of what is happening with a popular token known as TerraUSD, the world’s fourth largest stable currency, which has failed to maintain its value against the US dollar.

What is an algorithmic stable currency?

A stable currency is a type of cryptocurrency whose value is linked to other assets, usually fiat currencies such as the US dollar. They are designed to keep a stable price, making them popular when it comes to facilitating trade, lending, and lending other digital assets.

Some stable currencies, such as USDT USDTUSD
are backed by reserves that include US dollars, cash equivalents and other assets. Others, such as TerraUSD USTUSD,
or UST, they try to keep their pegs using algorithms.

What is Earth? How it works?

Earth is the world’s largest algorithmic stable currency and the 11th largest cryptocurrency by market capitalization as of Tuesday, according to CoinMarketCap. Terra aims to maintain a one-to-one link with the US dollar through an algorithm that controls the supply of UST and an associated cryptocurrency called LUNA LUNAUSD.

It is assumed that investors can exchange one UST for $ 1 of MOON, and vice versa. When the UST trades below $ 1, traders have incentives to buy a UST and exchange it for $ 1 of the MOON for profit. As UST burns to coin LUNA, the supply of the former will be reduced and its price will increase. When the UST trades above $ 1, traders may receive incentives to change their MOON for UST. As UST’s supply increases, so will its price.

Earth was growing at a breakneck speed: the price of LUNA rose from about $ 7 in July to an all-time high of $ 120 in April, before falling to $ 17, according to CoinDesk data. Anchor, a popular Earth loan application that pays up to 20% interest on cryptocurrencies, saw the value locked into the protocol increase from $ 1 billion in July 2021 to a maximum of $ 17.2 billion. of dollars on May 5, before falling to $ 5.9 billion. on Tuesday, according to data from DefiLlama.

Why is Terra in the news?

TerraUSD fell briefly to 99 cents on Saturday, before rising again to $ 1 on Sunday. On Monday, Stablecoin lost its stake again, dropping to 61 cents on the Binance cryptocurrency exchange. It is currently trading at about 79 cents, well below the crucial $ 1 level.

Luna also fell, with its price around 50% over the past 24 hours to about $ 16, according to CoinDesk data. The market capitalization of the token has fallen from more than $ 29 billion seven days ago to about $ 6.5 billion, according to CoinGecko.

What is the impact on the cryptographic ecosystem?

Investors are worried that the fall of the UST may increase the selling pressure of BTCUSD bitcoin,
which is already listed for at least 10 months. Some speculated that as UST lost its fixation, its sponsors would have to sell their $ 3.5 billion bitcoin reserves to support the stable currency.

Luna Foundation Guard, which supports the Terra ecosystem, voted in favor of issuing $ 1.5 billion in loans, half of them in bitcoins, to support the cryptocurrency, Do Kwon, founder of Terraform Labs, which drives the blockchain . wrote on Twitter Monday.

A Luna Foundation Guard representative did not immediately respond to an email requesting comments. Kwon did not respond to a request for comment.

Meanwhile, Treasury Secretary Janet Yellen quoted TerraUSD in a testimony before the Senate Banking Committee on Tuesday, saying the event “illustrates that it is a fast-growing product” that poses “risks to financial stability “.

Reads: Yellen says execution with UST stablecoin illustrates cryptocurrency risk for financial stability

Why did the UST plug break?

A large number of USTs withdrew from Earth’s most popular apps as of Saturday, according to blockchain data.

Anchor has seen an outflow of more than US $ 4.6 billion over the past seven days, starting on May 7 and accelerating on May 9, while some directions are repeated for large and early departures, noted Aurelie Barthere , chief research analyst at cryptographic data analytics firm Nansen. .

The reasons behind the intensive exit of UST are still unclear. Some analysts attributed the UST issues to a loss of confidence among investors.

“Algorithmic stable currencies are based on the confidence and confidence in the economic incentives of the underlying ecosystem of the stable coin issuer. Once that confidence and investor demand evaporate, they quickly fail in a spiral of Ryan Clements, a professor at the University of Calgary who has done research on algorithmic stable currencies, told MarketWatch by email.

The Earth model “required perpetual confidence in the assumption that there would be sufficient (ongoing) interest in the various cases of UST use in the Earth ecosystem (including the unsustainable yields of the Anchor protocol), sufficient support for cryptographic reserves being compiled, enough Negotiating Commissions to add to those reserves when they run out, and enough arbitration willing to constantly secure a fix without “withdrawing” from the ecosystem, ”Clements wrote.

What’s next?

Kwon tweeted on Tuesday that a recovery plan for UST was imminent:

“I’m sure they’ll find a way to fix it, but they’ll just have to spend a lot of money to do it,” Clara Medalie, Kaiko’s director of strategic initiatives and research, told MarketWatch in an interview. .

Even if the fixation is restored, some are concerned that investor confidence will be difficult to regain. “I think the whole story is such a classic cryptography. You’ve never seen so much hype in the last few weeks as you’ve done for UST, for decentralized algorithmic stable currencies, and it’s crazy how quickly it got rid of.” , said Medalie. “It captures a lot of hope for cryptography and how things can go so badly, that they haven’t been tested.”

Crypto investors are also watching regulators’ moves in light of recent events, especially “whether there will be any kind of collateralisation requirements that will be imposed on all projects that want to offer stable currencies,” said Michal Benedykcinski. , senior vice president of crypto. Arca asset manager.

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