Stablecoins: The Good, The Bad, and The (Very) Ugly ⚖️

Now this is a story all about how the 4th most valuable cryptocurrency crashed all the way down…

You guessed it—this week, we’re talking all about the craziness that happened in the market this past week. You may have seen buzzwords like “stablecoins”, “Luna”, and “UST”… but what are they, really? What happened this past week and why is everything tanking? Is crypto really worth the investment?

Don’t worry, we’ll address all of that and more. But first, I want to make sure we all start on a level playing field by breaking down a few concepts.

What are stablecoins?

Let’s start with something I’m pretty sure most of us can agree on by now: Investing in crypto is risky. This is largely because it’s not regulated by the government, unlike our current financial systems. Stablecoins were created as a way to give people the ability to invest in crypto, but with less risk (or so they thought).

According to CBS News, “Stablecoins are cryptos that are tied to a reserve asset such as a currency (like the dollar or euro) or a commodity (like gold, oil or real estate). Backing by other assets makes the value of stablecoins less prone to roller-coaster changes in price, hence the name.” 

Stablecoins are used to protect an investor’s money from the volatility and price swings associated with other cryptocurrencies, such as Bitcoin and Ether. Essentially, stablecoins are the tokenized version of fiat currency or other assets with fixed, unchanged value (like the dollar!).

In theory, any stablecoin that is fixed (or commonly referred to as “pegged”) to USD should always have a value of $1. Now onto the next section…

What are Terra Luna and TerraUSD?

As I was doing my own research, I came across a Buzzfeed article that answers this question perfectly! Check out an excerpt from their article below:

“While some stablecoins, like tether, are supposed to be backed by assets, others rely on complex algorithms to maintain their peg to the US dollar.

TerraUSD is one of these algorithmic stablecoins. It tries to maintain the same value as the US dollar by using a complex seesawing mechanism with a related cryptocurrency, which is called Terra Luna (or just Luna). While 1 TerraUSD is always supposed to be worth exactly $1, the value of Luna can fluctuate. In essence, TerraUSD uses Luna as a counterweight to maintain its dollar peg. Here’s how it works:

You burn, or destroy, TerraUSD to mint, or create, Luna, and vice versa. Burning one TerraUSD always gives you $1 worth of Luna, and burning $1 worth of Luna always gives you one TerraUSD. It’s like a seesaw, where TerraUSD is on one end, and Luna is on the other.

Let’s imagine the value of TerraUSD falls slightly so it is now worth $0.99. Because you can always exchange 1 TerraUSD for $1 worth of Luna, smart people will immediately take the chance to buy something worth $1 for 99 cents, and earn a small profit of 1 cent. So they burn their TerraUSD to mint Luna and earn a profit.

As more and more people holding TerraUSD try to earn that 1 cent of profit by burning it for Luna, the supply of TerraUSD reduces and its price rises until it hits its $1 peg.

Now imagine that so many people are taking advantage of the arbitrage that the price of 1 TerraUSD actually rises to $1.01. Now this means that people who are holding Luna realize that if they burn $1 worth of Luna they can get TerraUSD and make an extra cent in profit. So as more and more people burn their Luna to create TerraUSD, the supply of TerraUSD increases and its price falls until it hits $1.”

Now that we have this foundational knowledge, let’s get into what turned out to be a pretty bad week for crypto and “Luna-tics” (AKA Luna token holders lol) across the world.

So, what even happened in the market last week?

The Buzzfeed article has got us covered:

“Basically, the balancing act between TerraUSD and Luna broke.

The biggest reason that most people held TerraUSD was because of something called the Anchor Protocol. Think of Anchor as a savings account for your TerraUSD, but it pays you 20% interest — which is a really good deal for a savings account.

In past months, it made sense to simply park TerraUSD in an Anchor account and watch the 20% yield come in, especially because there’s not much you can actually use crypto for. Until as recently as last Saturday, 75% of all the TerraUSD in circulation was deposited in Anchor, according to Coindesk.

But in March this year, Anchor passed a resolution to replace the 20% rate with a variable rate. Then over the weekend, large amounts of TerraUSD were withdrawn from Anchor, the Wall Street Journal said, worrying traders and prompting them to sell their TerraUSD and Luna tokens. Another group of investors used a blockchain project called Curve Finance to swap TerraUSD for other stablecoins.

People started heading for the exits by burning TerraUSD in exchange for Luna. The supply of Luna ballooned, causing the price to plummet. In a sense, Luna was pushed off the seesaw.

As more and more people tried to dump their TerraUSD, the balancing mechanism stopped functioning — TerraUSD crashed, and so did Luna. The stablecoin plummeted to $0.14 at one point Friday. Luna has become almost worthless, tanking to less than 1 cent on Friday as well.”

You really hate to see it… :/ I am not invested in Luna (y’all know where I’m hedging my bets), but I know several people who are. It’s a very unfortunate situation, and definitely one we can all learn from. If anything, it further confirms that we’re still extremely early and even the most popular cryptos are susceptible to taking a downturn.

My thoughts 🙇🏽‍♀️

I almost called this section “Kendall’s Krypto Korner” until I realized… nvm—LOL. Anyway, here are my quick & dirty takes:

Regulation is necessary.

I believe we need regulation—or at least some form of it—by the government to ensure crashes like these don’t happen again. In my opinion, this is the next step before we’re able to get to mass adoption. In a world with regulations, Luna may not have been “pushed off the seesaw” and the market would have stopped itself before going to zero. I’m curious how regulation and decentralization will co-exist though, especially since so many major companies have invested in Bitcoin and other crypto assets. Swings in the crypto market will inevitably have implications on the larger financial markets. So that begs the question… is this even really decentralized? Would love to hear your thoughts on this, as it’s something I’m constantly thinking about! LMK in the comments :)

Utility will win the long game.

I personally believe that the blockchains (and their respective cryptocurrencies) that have real world utility will appreciate in value over time and make it through the volatility of the market. And they hopefully won’t crash to zero like Luna did! This is the key difference between investing in ETH and Luna. ETH powers a blockchain (Ethereum) focused on real world utility, while the Luna was used to peg TerraUSD and was largely based on algorithms. All that to say, no real world utility except to keep TerraUSD afloat, if that counts.

Investing in learning during a down market is key.

Crypto is not dead, and it likely is here to stay forever. However, not everything will last and the ability to develop some type of conviction around why you’re investing in a cryptocurrency (outside of “my friend told me to”) will serve you well. It’s completely okay to acknowledge that you don’t understand something enough to invest in it, but the amount of falsely guided buys that ultimately led to some serious financial L’s is alarming. There were some sources recommending people buy $LUNA up while it was at 14 cents… LOL never in a million years would you recommend that if you truly understood how this technology works. Luna is very much tanking and people are losing real money—and lots of it. Be smart about your investments and don’t let FOMO have you investing your life’s savings in something you don’t have conviction around. Take the time you need to do your own research and form your own opinions!

This week’s recommended action: Read Do Kwon’s reconciliation thread on Twitter!

For context, Do Kwon is the owner of Luna and the co-founder of CEO of Singapore-based Terraform Labs. He’s essentially the man who’s taking the fall for the rapid declines of TerraUSD ($UST) and $LUNA. You really hate to see it. Nonetheless, here’s what he said today, May 16th, in regards to the path forward.

What are your thoughts on all of this? I’d love to know!

✌️

Kendall