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TerraUSD plunge: LUNA keeps falling. Are other algo stablecoins in peril?

03:03, 11 May 2022

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An illustration representing Terra’s ecosystem
LUNA is down 94% in a week after UST’s depegging – Photo: Shutterstock

Sometimes a picture is worth a thousand words, and this was the case of a chart representing TerraUSD’s plunge, which had been posted on Twitter and simply captioned “stablecoin”. Cryptocurrency circles have been booming with puns on the stability of the TerraUSD (UST) – a stablecoin – which is supposed to be value-pegged with the US dollar and which was at one point worth $0.30 on Tuesday. Following TerraUSD’s collapse, its sister token LUNA went crashing down almost 86%. Are other algorithmic stablecoins (algo stablecoins) in danger? 

TerraUSD’s depegging is the most discussed topic in the cryptocurrency world. Before the sell-off, TerraUSD was the third biggest stablecoin, but following the meltdown, the token had sunk to the 20th biggest coin by market capitalisation.

Unlike traditional stablecoins, such as tether (USDT) that purpots to have reserves in traditional assets like cash and money instruments, TerraUSD is an algo stablecoin and, as such, it doesn’t have reserves in traditional assets. Instead, Terra’s ecoystem has incentives in place for traders to mantain the stablecoin’s value in place. Terra blockchain has two tokens – TerraUSD and LUNA. TerraUSD – the stablecoin out of the two – is supposed to trade around $1. To ensure this, the Terra blockchain’s algorithm is constantly adjusting the total supply of coins in circulation through a process known as the minting and burning of tokens.

LUNA’s meltdown

TerraUSD’s plunge hit its sister token, LUNA, hard. 

LUNA increased 100x in value in 2021 and continued to be one the best crypto performers amid the 2022 downturn. But in the wake of TerraUSD’s plunge, LUNA lost half of its value in a day. The meltdown led the Luna Foundation Guard (LFG) to buy LUNA, selling its recently acquired BTC stash.

LUNA is now down 86% day-on-day and 94% week-on-week. It was trading at $4.89 on Wednesday morning at the time of writing – well bellow its all-time high of $34.28.

“$LUNA Will hit 1$ before $UST,” a poster nicknamed rkn_95 wrote on CoinMarketCap.com.

As the very system behind algo stablecoins is brought into question, are other algo stablecoins in danger of crashing?

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TRX rally, interrupted 

TRX had rallied last week on the back of Tron launching an algo stablecoin, USDD, on 5 May. This was in defiance with the rest of the cryptomarket, which was in downturn. However, the TRX rally was halted the day after TerraUSD’s chaos.

TronDAO (decentralised autonomous organisation) had written on Twitter. “TRX and USDD holds steady in today’s market volatility. It is our mission to safeguard TRON ecosystem as always! In TRX we trust!”

In a similar move to LFG, TronDAO also decided to buy TRX to help soften the blow. 

Traditional stablecoins to the rescue?

As people are parting with their algo stablecoins, could traditional asset-backed stablecoins benefit?

Capital.com analyst Piero Cingari says that as traders start looking for a safer space cryptocurrency in the wake of TerraUSD chaos, they may be better off looking at commodity-backed stablecoins, and he highlights the role of ‘Pax gold’, a digital coin backed by physical gold secured and stored in Brink’s vaults, may arise in this context.

Cingari cautions traders looking to flee algo stablecoins to traditional stablecoins: “The proliferation of the stablecoins is a result of the Federal Reserve’s flood of markets with liquidity in recent years and the herd behavior of retail traders,” he says. “But it’s only when the tide goes out that you learn who has been swimming naked, to use a famous quote by Warren Buffett.

“Any currency, whether fiat, digital or stablecoin, is inevitably dependent on the issuer’s confidence, which raises the question of what exactly supports confidence in these pegged currencies and what assets can sustain withdrawals.”

Cingari’s words come as the Fed reiterated its warning about stablecoins posing risk for financial stability in a report published this week.

“The promised ‘free lunch’ of +20% returns on the crypto stacking is simply too good to be true,” Cingari adds.

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