The moon (LUNA) has set – what comes next?
What an absolutely mad week it has been for crypto. Seeing the second largest DeFi-centered blockchain go from hero to literal zero in the space of a couple of days is really a sight to behold. As of today May 16th, the price of LUNA stands at less than $0.0002, with the Terra blockchain being halted at block height 7.603.700. Despite efforts by Do Kwon to rebuild, as well as proposals on Agora to reimburse those who have been affected by the depeg event, there doesn’t seem to be any way for the people who have lost the most to actually recover their funds.
I can’t really think of any instance in crypto (or many others in other industries) where the shareholders have been reimbursed for a project that literally went to 0. Even when this does happen, it tends to give back money to whales, as Vitalik Buterin also implies.
The ripple effects of the Terra debacle are wide-reaching and not yet over. The whole market has taken a nose-dive with Bitcoin going even as low as $25.298 last Thursday. UST was also widely used in other protocols and was collateralized against by many other assets and stablecoins. With all of this money essentially disappearing from the markets, many other potential protocols are in clear danger of failing in the near-medium future.
Of Terra, Bears and Tethers – The impact of UST on crypto
UST losing its peg to the US Dollar has created a contagion event throughout stablecoins and the wider crypto markets. Other algorithmic stablecoins and seigniorage projects have also either completely depegged (DARK on Cronos for example) or are way off their peg for the time being (TOMB on FTM). Other stablecoins like DEI have also lost their 1:1 ratio with the US Dollar.
USDT is by far the largest stablecoin by market cap - $81B. Second is USDC with roughly $48B, then BUSD with $17B. The reasons why other stablecoins and the market are being affected by UST depegging are as follows:
1. UST was involved in a vast number of Defi protocols and was being used in pools, money markets and staking. This means that every pool that offered stablecoin liquiditiy is now suffering from massive impermanent loss. Pools that for example were supposed to be 50/50 USDT/UST are now 90%+ UST <10% USDT. See example on the chart below with one of the largest liquidity pools in crypto in general. This means that the “good” stablecoins are being liquidated in order to cover for UST. Which in turn puts sell pressure on the non-UST stablecoins, making them go lower in price. People see this, they panic and want to sell even more, thus further putting sell pressure. If the foundations/algorithms behind the respective stablecoin don’t have enough treasury collateral to buy the coin back up to repeg, they face a massive depegging event. See below an ominous screenshot from Curve.
2. Liquidation cascades due to lending/borrowing. Many major money market protocols support the major stablecoins: USDT/UST/USDC/BUSD/FRAX/TUSD etc. Usually, many wallets lend out their stablecoin to get a collateral in a different stablecoin or asset. With UST depegging, many of these strategies are going through what is called a liquidation cascade. Ex: Lend UST, borrow USDT against it, yield farm USDT on Stargate to receive STG rewards, sell STG. UST depegs, therefore liquidating the STG and USDT positions. Liquidations = sell pressure on the assets = price goes down.
3. Stablecoins run on trust. We are essentially dealing with tokenized fiat that is very convenient to use. However, this also means that they are exposed to the same disadvantages, namely trust. If people lose their trust on the value of a currency, they try to exchange it for a different one. A recent example would be Russians trying to sell their Rubbles for Dollars in the midst of sanctions against the Russian Federation, only to have the Central Bank ban its selling and artificially trying to create buy pressure to prop it up. This is also happening in crypto now as there is a powerful migration from many other seigniorage/rebase and algorithmic stablecoin projects to perceived safe havens.
4. UST was used as collateral for other stablecoin treasuries. Algorithmic or not, every stablecoin needs to prove that it has enough liquidity in order for it to be a liquid exchangeable asset. In the case of DAI, for example, roughly 40% of it is backed by USDC, which in turn, is an (admittedly) collateralized asset. DAI is pretty awesome because it’s a truly decentralized stablecoin run by a DAO. We all have biases, I am being honest with mine.
This is all good, however let’s take MIM, another overcollateralized stablecoin. I want to point something out here, seen on Steven’s Youtube channel (awesome analysis by the way). MIM usually have a pretty awesome analytics tab where one can see live on-chain data for MIM. That analytics tab is now disabled and says “work in progress”. However, if you right click on it and open in new tab, you get the latest updated version of it since March. There we can see that the majority of MIM had UST as collateral. Not cool Abracadabra Money, not cool.
What this could mean for USDT
One of the biggest nightmare scenarios in crypto for a long time has been a potential depegging of USDT. Roughly 70% of the treasury and funds of all major centralized exchanges is exposed fully or in part to Tether. As Tether has never properly been audited, we have no idea how many times they could repeg. It went through a depeg event going as low as $0.95 and has regained stability…for now. This is not the first time that USDT has lost its peg and it has always regained it.
However, back in 2017 and 2018, USDT did not have a $80B+ market capitalization. The EXACT same thing happened with UST back in May, UST lost its peg, the algorithm did its magic, people burnt LUNA for UST, peg was regained. However back then, there was a total of $260M in deposits on Anchor. Before the peg broke earlier this week, there were $14B in deposits worth of UST.
This brings two potential outcomes:
1. USDT Is too big to fail, which means that somehow; *cough* *cough* backdoor deals *cough* *cough* will be made to re-collateralize USDT enough for it to regain its 1:1 peg. In that case all is good and market confidence is restored.
2. USDT goes through a strong depeg event which will be exponentially more impactful than UST and bring a significant portion of the crypto market down. This means centralized exchanges, treasuries of other projects, valuations, protocols, liquidity pools, etc. will go through a crisis the likes of which crypto hasn’t ever seen before.
Regardless of where Terra failing leaves the market, some things are certain in my eyes: crypto is going through yet another tumultuous period, emotions are high as a lot of people have lost money and blame is going all around, from the lack of regulations, to a perceived inherent ponzinomic nature of crypto, to people being too naïve. At this point the source of the UST depeg has all but been unofficially confirmed to be two certain hedge funds that I won’t name because they deny the allegations. I am kidding, it’s apparently Blackrock and Citadel. Crypto will survive this as it has many other downtrends in the past. Algorithmic stablecoins will have to change a lot. DeFi is not going anywhere and calls to regulate it will be heard and sternly agreed with. As the LUNA goes under, the sun will rise on different projects months and years from now. Welcome to crypto.