TerraUSD had a value of $1, with a market value of nearly $19 billion at its peak, before it plunged last week and ended at just 16 cents on Friday.
Tokyo (Japan)- The plunge in the value of TerraUSD, one of the biggest cryptocurrencies, has strengthened the resolve of regulators worldwide wanting to tighten oversight of the crypto trading system.
TerraUSD had a market value of nearly $19 billion at its peak before it plunged last week from $1 per token to just 16 cents on Friday. U.S. Treasury Secretary Janet Yellen said stablecoins – like TerraUSD, which are tokens pegged to fiat currencies such as the U.S. dollar – present risks to the traditional finance system.
The collapse of one of the largest cryptocurrencies, and plunging prices of dozens more, have shaken confidence in the crypto market. But there is one group of people whose faith has only been strengthened: regulators.
Financial watchdogs worldwide have been warning of building risks in cryptocurrency and have been handed ammunition to call for new powers to regulate the industry.
Immediately in their sights are so-called “stablecoins,” tokens pegged to fiat currencies — typically the U.S. dollar — that act as a bridge between the traditional financial system and the crypto trading ecosystem.
At the heart of this week’s turmoil was TerraUSD, also known as UST, a stablecoin that was supposed to keep a value of $1 and had a market value of nearly $19 billion at its peak. It lost parity with the dollar a week ago and by midweek had plunged. It was worth just 16 cents on Friday.
The crash prompted crypto traders to question a broad range of their investments, from bitcoin, the largest and oldest cryptocurrency, to smaller coins.
Tether, the most popular stablecoin, with a market cap of $80 billion, also broke its $1 peg on Thursday, at the peak of the market turmoil, but it has since edged back up to near $1. Unlike “algorithmic” stablecoins like TerraUSD, which try to maintain their peg with a complicated trading algorithm, Tether says hard currency assets back it.
“There are limits to algorithmic stablecoins,” said Genki Oda, CEO of Japanese crypto exchange operator Remixpoint. “Going forward, only stablecoins with sufficient assets will likely survive.”
He said the impact will not be significant in Japan, where stablecoins are not yet listed on most licensed exchanges. But the fallout may make local regulators extra cautious. Japan’s financial regulator is considering requiring issuers of stablecoins in the country to obtain a banking or money transfer license.
“The Japanese government will move accordingly to the global trend,” said Jun Yokoyama, a Daiwa Institute of Research researcher. “The current proposed legislation aims to balance innovation and safety, but the rules can be revised.”
In the U.S., Janet Yellen, the U.S. Treasury Secretary, had pointed to the run on UST during a congressional hearing on Tuesday to call for more regulation. “I think that simply illustrates that this is a rapidly growing product and that there are risks to financial stability, and we need an appropriate framework.”
“We expect recent developments to lead to increased calls for regulation of stablecoins,” analysts at credit rating agency Fitch wrote this week.
The total market capitalization of all cryptocurrencies was $1.3 trillion by the end of Friday, $280 billion lower than the start of the week, according to CoinMarketCap. Even after the wipeout of UST, the value held in stablecoins is still above $150 billion.
The sudden crash was a stark reminder of the vulnerability of crypto projects, even ones that are worth tens of billions of dollars on paper.
UST relied on a mechanism that incentivized investors to maintain the dollar peg using a sister token called Luna. Luna had a market cap of $30 billion before the attack, making it one of the top 10 coins globally. Its price fell even more dramatically than UST, from a high of $118 in April to 1 cent by Friday.
Owners of UST and Luna had called themselves Lunatics, creating a community to make the project successful. Supporters created various applications, such as marketplaces for trading non-fungible tokens, using the Terra blockchain on which UST and Luna are based.
The impact this time is more severe than previous stablecoin failures because a whole ecosystem collapsed,” said one employee at a Japanese crypto startup. Some people claimed to have lost their life savings. “This is the biggest death spiral we’ve ever seen,” tweeted one user.
Founded in 2018 in South Korea, Terra was initially designed as a payment solution for online shopping. Do Kwon, the outspoken Stanford-educated co-founder who has become the face of the project worked on it with Daniel Shin, the former chairman of South Korean e-commerce company Ticket Monster.
Shin had been looking to use blockchain technology to reduce the fees e-commerce companies were paying to credit card companies, according to people close to the project and interviews in the past. An idea for a stablecoin was hatched, with a plan to drive up adoption by offering promotions for using it on e-commerce sites.
UST aimed to keep itself stable by allowing one dollar’s worth of Luna to be swapped with one UST, a mechanism designed to incentivize users to profit by selling or buying the coins whenever the price of UST deviates from the peg. Under its original plan, owners of Luna were to receive a share of the transaction fees generated by UST by helping validate the transactions and creating a decentralized payment network.
The payments business struggled to take off, partly due to regulatory uncertainty in South Korea and other markets overusing crypto as a payment method. Kwon then created new demand for UST: a decentralized finance application called Anchor Protocol, which paid out a near 20% interest in the form of crypto to users who lent out their UST. It quickly became one of the most popular de-fi apps due to its high-interest rate, but ultimately turned out unsustainable.
Users had posted Luna and other cryptocurrencies as collateral to borrow UST on Anchor, creating a domino effect when the panic selling began.
Stablecoins have become a popular tool for trading cryptocurrencies because they are less costly and easier to move around than fiat currencies. “There could be significant negative repercussions for cryptocurrencies and digital finance if investors lose confidence in stablecoins,” the Fitch analysts wrote. “The latter play an important role in catalyzing the crypto ecosystem more broadly, by providing a stable link to fiat-currency financial markets.”
An Asia based venture capitalist that invests in crypto startups said the week’s turmoil might slow the growth of new blockchain projects, such as Polkadot and Cosmos, that have been competing with Terra to become an alternative to the bigger Ethereum blockchain.
In light of the crash, Kwon said that he would work to revive UST in a Twitter post. “We will adjust its mechanism to be collateralized,” he said, signalling that he plans to give up the algorithmic mechanism for one akin to a more conventional stablecoin.
His co-founder Shin is currently the CEO of Chai, a startup that helps e-commerce companies accept a variety of payment options, including credit cards.