Find out what Tether’s first CEO, Reeve Collins, is saying about the future of stablecoins
The recent demise of UST has triggered an alarming response, raising questions about the true stability of the so-called “stable” stablecoin, along with a wave of conspiracy theories to follow. On the surface, the crash of UST and its sister currency, LUNA, has rattled the broader crypto market. However, every market experiences this type of turbulence, and the recent collapse of the Terra ecosystem and its UST stablecoin cannot be compared. While Terra investors were the ones who took the initial hit, and the crash may have both short and long-term effects on the crypto economy, its downfall serves as a necessary corrective mechanism that can drive the industry to the next level.
It is no secret that cryptocurrency is known for its extreme volatility, exacerbated by the collapse of the Terra token economy. Nonetheless, this series of events serves as an unfortunate reminder that some of crypto’s perceived safe havens, like algorithmic stablecoins, are risky. But it is important to remember that algorithmic stablecoins are not indicative of the crypto ecosystem as a whole, let alone the broader crypto economy. These types of market highs and lows are prevalent across all asset classes, traditional and digital, and crypto will likely continue to experience market downturns like this as the economy continues to mature.
UST was once the hottest topic in the crypto industry at its inception and made one of the biggest experiments in decentralized finance to date with extensive financial guarantees. It was once hoped that UST — a stablecoin pegged to the U.S dollar — would reinvent traditional payment systems around the world. Unlike many crypto projects, which are niche and confined to hardcore traders, LUNA gained extreme traction, transcending it into mainstream media, after nearly 18 months of skyrocketing growth. The coin, which was once valued at more than $100 a month ago, is now only worth a fraction of a penny.
What happened, exactly?
The main cause of the crash is complex, but the breakdown started when UST lost its peg to the U.S. dollar, which left many investors wondering what happened to the coin that once was a top crypto asset. Investors panicked and tried to pull out their money, causing a decline in portfolio holdings that diminished the value of both UST and LUNA, both almost going to zero.
In fact, the meltdown sparked concern in even the largest collateralized stablecoins. As a whole, these tokens serve as a critical component of the crypto economy, designed to provide the best aspects of both new and old financial models that feature the decentralization and accessibility of cryptocurrency and the value stability of fiat currency. Traders depend on the stability of stablecoins to move and lend money with confidence when the decentralized finance (DeFi) markets get unruly. The different types of stablecoins are labeled according to their underlying collateral structure, which can be fiat-backed, crypto-backed, commodity-backed, or algorithmic.
Boundary-pushing stablecoins are not over
On the surface it may look as if stablecoins are failing to live up to their once untouchable image. In fact, this is not a crypto-wide issue, nor is it a stablecoin issue, this is an algorithmic stablecoin issue. UST is an algorithm-backed stablecoin —issued and backed through the LUNA —that provides a growing array of decentralized finance applications. Algorithmic stablecoins are a potentially promising use case of DeFi and complex smart contracts, but as of now, in their simplest form, they are a bet on a math equation behaving as its creator intended. It is essential to carve out a very clear distinction between fully-backed stablecoins like USDT (Tether) and algorithmic, or basket-backed, instruments like UST. UST sets itself apart from other stablecoins as it maintains its peg to the U.S. dollar through algorithmic code that changes with supply and demand for LUNA, as well as being an asset type that is categorically different from fiat-backed stablecoins such as USDT. When using a fully-collateralized stablecoin instead of an algorithmic instrument, there is a consistent store of value and far fewer counterparty risks.
With that being said, fluctuations in any market are inevitable. In fact, stress tests are a part of the financial ecosystem. When applying this same mindset to stablecoins, there is no systemic risk to the ecosystem as a result of what happened with UST, though its issues have had a negative impact on many. In unpredictable market conditions, stablecoins like USDT will have significantly less volatility and will be far less subject to price fluctuations.
So, what’s next?
The positive utilizations of stablecoins far outweigh the recent negative press, especially in the DeFi and the Web3.0 world we are quickly entering into. Stablecoins lay the foundation for these emerging applications to even be possible. There’s no question that the UST crash has caused investors to question their trust and confidence in the stablecoin ecosystem, but the Terra project has provided innovations that could get crypto back to its near-$3 trillion peak.
While most view LUNA’s crypto crash as a catastrophe, for investors, it is important to view the crypto economy as they would any other investment. As a rule of thumb, investors should understand their personal risk tolerance when creating a strategy for their portfolio. When it comes to building a cryptocurrency portfolio, managing risks in a volatile market is essential to protecting your gains. In light of the UST debacle, the stablecoin economy is far more stable than many think. Even though the Terra experiment failed, the failure holds a valuable lesson for investors and developers in future algorithmic approaches.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.