The Crypto Financial Crisis – POLITICO


With help from Derek Robertson

Last week’s collapse of cryptocurrency TerraUSD punctuated a downturn that erased $900 billion of cryptocurrency value in a month and a half, according to Data from CoinMarketCap.

It also raised bigger questions about the long-term outlook for crypto. TerraUSD was a “stablecoin”, a class of digital tokens meant to maintain a stable value against the US dollar, which is supposed to allow predictable investments like those offered in the traditional financial world.

But it was also a complex instrument that many people had doubts about, which doesn’t necessarily reflect the underlying dynamics of simpler stablecoins or longer-established systems like Bitcoin and Ethereum. What happens next – not just in terms of crypto valuations, but regulation and oversight – depends on how investors and policymakers understand what just happened.

So what happened?
Stablecoins like Terra are meant to maintain a stable value against conventional currency, usually the US dollar. This makes them attractive to some investors, but also means they are exceptionally vulnerable in a crisis.

If holders lose faith that tokens will actually hold their value, stablecoins may be subject to a digital bank run, just like the one that sank Terra.

In the case of Terra, large withdrawals from a sort of digital savings bank that held much of the existing stablecoin supply worried many Terra holders, who rushed to sell off at once. Terra and a related token, Luna – whose purpose was to stabilize Terra’s supply. priced at $1 – lowering the price of both. This price drop caused panic and a crash in the price of both tokens.

Wait, that $1 idea sounds familiar.
Yes. Stablecoins have a lot in common with money market funds, in which dollar deposits are supposed to be redeemable on demand. For decades, money market funds have offered a higher return than savings accounts, while providing about the same level of predictability and stability.

One of the dominoes to fall in the last global financial crisis came when the world’s oldest money market fund ‘broke the ball’ – plunging below the dollar-indexed value it was supposed to maintain – in September 2008. This sparked a deposit rush. of those funds, and the Treasury Department was forced to step in and guarantee the value of the funds.

How similar are they really?
Terra’s failure was far less shocking than a money market fund that broke the ball, given the newness of crypto assets in general and the experimental nature of Terra in particular.

The first generation of stablecoins derived their value from the promise that holders of the digital token could go to their issuers and exchange them for regular dollars. The issuers of these coins hold reserves that include dollars and highly rated bonds, although the exact size and composition of the reserves backing the largest stablecoin, Tether, has been a matter of debate. ongoing controversy.

Terra was part of a new generation of experimental stablecoins called algorithmic stablecoins. TerraUSD issuers have not promised to redeem the tokens for dollars. Instead, Terra depended on a hard-wired incentive system that allowed traders to trade them for Luna, and vice versa, in a system designed to keep Terra’s value pegged to the dollar.

Between them, Terra and Luna have reached a market value of tens of billions of dollars, despite the lack of outside assets supporting the system. Naturally, this raised concerns about a bubble.

In recent months, Terra backers have started buying large amounts of Bitcoin in what used to be describe with the aim of strengthening the stablecoin. But those bitcoin holdings were a fraction of Terra’s market value, and when faith began to falter, Terra’s backers couldn’t absorb the wave of selling that followed. Meanwhile, the algorithm that allows Terra to be swapped for Luna and vice versa couldn’t force anyone to pay real money for either token, and the value of both went up. collapsed.

Who watches this system?
Even before the failure of Terra, stablecoins were under intense regulatory scrutiny. In November, the President’s Financial Markets Task Force issued a report calling on Congress to write rules for coins, and in April, Sen. Pat Toomey (R-Pa.), law Project that would establish federal licensing requirements.

The industry also had concerns, particularly regarding the algorithmic approach to stablecoins. Like a big title in crypto-focused publication Coindesk put it weeks before the implosion: “’Built to Fail’? Why TerraUSD’s growth is giving financial experts nightmares. »

What happens next?
During its brief existence, dramatic price swings and catastrophic failures have been regular occurrences in the digital asset market. But as this market expands and integrates into the wider financial system, the consequences of events like Terra’s failure become more severe.

An immediate consequence was a renewal of calls specifically regulate stablecoins. Some policymakers would like to see them backed by federal deposit insurance similar to the program that guarantees traditional savings accounts.

The collapse could also contribute to a broader market slowdown. According to a report to Bloomberg, traders in other markets are worried about ripple effects if crypto losses cause retail investors to dump other risky assets, like stocks.

What does this mean for crypto?
The failure also has implications for the development of other cryptocurrencies. Part of the appeal of algorithmic stablecoins is to provide a dollar-like instrument without being backed by actual dollars. If a major stablecoin could maintain a stable dollar with algorithmic incentives and the sole support of Bitcoin, it would be a sign that the crypto ecosystem was becoming more mature and independent of pre-existing financial systems. As Do Kwan, CEO of TerraForm Labs, has Put the: “decentralized economies deserve decentralized money.”

The failure of Terra means that decentralized finance remains largely dependent on traditionally backed stablecoins, and therefore reliant on ties to the conventional financial system.

The NBA playoffs are in full swing, and as all sports enthusiasts know, there’s one constant to their ups and downs: you’ll see the same ads, featuring the same stars, plugging the same products, dozens and dozens of times. (Call it the universal law of state farm.)

As anyone who watched the Super Bowl or went to the movies in recent months may have noticed, crypto buys a lot of ads, and the NBA is no different. Enter Steph Curry of the Golden State Warriors, touting the ease of use of the FTX crypto exchange for non-tech savvy investors.

Curry is far from the first NBA star to enter the crypto sphere – Miami Heat star Jimmy Butler has in partnership with Binance; LeBron James has teams up with Crypto.comthe company that conveniently purchased the naming rights of its Los Angeles Lakers Arena. But Curry’s announcement is particularly ripe for interpretation: we see him browsing his (surely fictional) portfolio in FTX’s app, with a position of $5,758.34 in Bitcoin and $4,311.34 in Ethereum. . (Let’s say, for example, that if these values ​​were valid on March 29, the date on which the ad was uploaded to youtubeCurry would have taken a hell of a beating from both.)

Of course, success in those positions is no big deal for a league MVP and three-time NBA champion who earned $45 million this year in salary alone. For small investors who have lost much of their life savings over the past two weeks, it’s a whole other story, something that could lead to a closer look at the wave of publicity around the fledgling industry. — Derek Robertson

Keep in touch with the whole team: Ben Schreckinger ([email protected]); Derek Robertson ([email protected]); Constantin Kakaes ([email protected]); and Heidi Vogt ([email protected]).

Ben Schreckinger covers technology, finance and politics for POLITICO; he is a cryptocurrency investor.

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