Panic winds in the stablecoin market. Terra USD, the Terra blockchain stablecoin, failed to resist the recent decline in the cryptocurrency and deviated significantly from parity with the dollar.
The Terra USD (UST) stablecoin on the Terra blockchain has risen since its inception in 2020 to become the fourth largest stablecoin by capitalization, currently at $16 billion according to Coinmarketcap. However, in the context of a strong tremor in the cryptocurrency market on Monday, this stablecoin lost its peg to the dollar, declining by 9% in one day, reaching a value of only $0.67, before rising as follows.
If we look at the differences in the prices of stablecoins, “there is always a little fluctuation in their price against the dollar, but here we have not seen such a strong divergence in a stablecoin of this size,” explains BFM Crypto Laurent Pignot, financial analyst at Zonebourse. So, how do we explain this fall in this stablecoin?
stablecoin principle
First of all, you need to understand the principle of stablecoin. A stablecoin is a type of cryptocurrency whose value is backed by the value of a fiat currency, mainly the dollar but also the euro. Stablecoins, the most famous of which are USDT (from Tether) and USDC (from Coinbase and Circle), especially seek to reduce the risk of fluctuations in the cryptocurrency market.
The largest stablecoins, which account for about 90% of stablecoin trading today, work like this: the company issuing the stablecoin (eg Tether for USDT) must ensure that there are as many dollars in reserve as there are stablecoins in traffic . Thus, if a customer wants to sell their stablecoins for dollars, then surely there is enough money in the vaults of this company to make this conversion. So it is parity based on the stock of “real” money available to the issuer of the stablecoin.
On the contrary, Terra USD is a stable currency that works with Luna cryptocurrency and cryptographic algorithms. The complex architecture of the algorithms makes it possible, thanks to the Luna cryptocurrency and a basket of coins, to preserve the floor treasury of one dollar … in theory.
“For example, by buying or selling Luna, the algorithms will lower or increase the price of the floor treasuries to reach parity with the dollar. When there is a significant rise or fall. When Terra USD and the basket of currencies it supports, its value fluctuates. About $1 ($0.9998 or $1,0012), algorithms take on the role of a stabilizing factor,” Laurent Pinnott defines.
How do we explain the fall of Stablecoin Terra?
Let’s go back to what happened on Monday. For several days, the cryptocurrency has been dropping, and Bitcoin has dropped below the $30,000 mark. Thus, the Luna cryptocurrency, the thirteenth largest cryptocurrency in the market by capitalization, is down 44% in one day, and its value at the time of writing this article is $33.
“Sales demand was so strong for cryptocurrencies and cryptocurrencies that the floor treasury algorithms could not withstand this shock of volatility,” explains Laurent Pignot. In addition, the Luna Foundation, which oversees the Terra blockchain, has purchased a stock of bitcoin to be able to intervene in the event of a problem: in this context, it has mobilized the equivalent of $1.5 billion in bitcoins to be retrieved. Ground tank at equilibrium.
Faced with such algorithmic flaws, the stablecoin has lost credibility with its users. In the short term, “people will start abandoning them due to the risk of a volatility shock while stablecoins are supposed to be a store of value in the cryptocurrency ecosystem,” asserts Laurent Pignot, who believes users will switch to other stablecoins.
However, Terra is still a blockchain that was created in 2018 and is being used for some decentralized applications, “which means there will always be users who will need a UST to use the applications. But for users who are speculating, they will turn to other stablecoins. Terra should lose A lot of capital in the short term, ”emphasizes the expert.
No effect on the stablecoin market
Despite this scenario, remember that Terra USD represents only 1% of the stablecoin market, which currently stands at $1,473 billion. “The problem encountered in terrestrial treasuries is serious for this stablecoin and the Luna project, but it will not affect the parity of the two largest stablecoins, USDT and USDC,” explains BFM Crypto Romain Saguy, Director of Marketing and Commerce at Coinhouse.
Moreover, “Fortunately, there is still relatively little use of terrestrial reservoirs in the cryptocurrency ecosystem, and in particular they do not have a direct impact on Ethereum projects. It is likely that the project will be able to survive in the short term at least, and if we are looking for a point Positive in these problems, is that, in the end, it will enhance the security of the entire market, either by disappearing a project with unsettled rules, or by securing and perpetuating its operation” stresses Coinhouse in a note published today.
Around 4 PM, Terra USD was still showing at just $0.88.