TerraUSD Collapse is a Teachable Moment in Crypto

Posted by Patti Wubbels on May 19, 2022 12:01:10 PM


Perspective matters when it comes to cryptocurrency.

The demise of the TerraUSD stablecoin has understandably spooked the markets. Any sudden freefall will panic people and make them wonder what’s next.

Investors, and FIs looking to offer crypto services, need to read between the lines and view this crash as an educational opportunity.

The SRM Crypto Advisory team regularly highlights the distinctions between cryptocurrency, altcoins, stablecoins, and nonfungible tokens (NFTs). There are also key differences within each of these groupings.

Let’s look at the situation that occurred with TerraUSD.

Stablecoins, by definition, are stable because they sit safely on the blockchain and are pegged to a near-cash equivalent. USDC, USDP, and USDT, for instance, offer a 1:1 peg to the US dollar – which seems stable.

In contrast, TerraUSD, once the third-largest stablecoin by market cap, was an algorithmic stablecoin.

While a share of its value was tied to the dollar, another portion was linked to the utility token Luna, which lacks a stable price and creates the potential for more volatility.

There was a significant TerraUSD selloff that caused its price to plummet. It had a corresponding impact on the Luna token, causing a run of people trying to get out.

It is worth noting that Luna’s treasury was shored up in recent weeks with billions of dollars of Bitcoin. But the Bitcoin was liquidated last week to ease the run on TerraUSD, which delivered what we believe to be a short-term hit to the price of Bitcoin (and other forms of crypto).

Finding a Silver Lining

This, in a broader sense, wasn’t a terrible thing because it brought to light the importance of having regulation in place. Failure is the best teacher. Terra’s collapse should convince more people of the need for rules in place to avoid something similar from happening in the future.

It is also important to note that at least 40% of crypto owners bought into the market in the last year, so many investors had yet to experience a swoon in valuations. The last major decline in crypto occurred in 2018 – newer investors needed to learn that what goes up does go down (and likely back up again).

We continue to believe that crypto is entering the mainstream and is here to stay. Too much energy has been invested in the technology and infrastructure for it to simply go away. Regulation should provide more underlying confidence.

The Bottom Line

We will continue to see crypto at the crossroads of traditional finance and innovation – creating a marketplace with fewer friction points, lower costs, and quicker settlement.

FIs need to look at the big picture and take a long-term view of the crypto market. While the overall system endures tests, it should also become more resilient. As more people understand the underlying dynamics, the system can stabilize.

Topics: Cryptocurrency, Digital Assets, Stablecoins, Blockchain, Crypto

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