Wind of panic on the stablecoin market. The Terra USD, the stablecoin of the Terra blockchain, failed to resist the recent fall in cryptocurrencies and deviated very widely 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 weighing in at $16 billion. according to Coinmarketcap. However, on Monday, in the context of a strong jolt in the cryptocurrency market, this stablecoin lost its peg against the dollar, falling 9% in one day, until it was worth only 0.67 dollars, before rising by the following.
If we look at the variations in the prices of stablecoins, “there is always a little volatility on their price against the dollar, but here we had never seen such a powerful variation on a stablecoin of this size”, explains to BFM Crypto Laurent Pignot, financial analyst at Zonebourse. So, how to explain such a fall of this stablecoin?
The principle of a stablecoin
First of all, you have to understand the principle of a 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 best known of which include USDT (from the company Tether) and USDC (from the companies Coinbase and Circle), seek in particular to reduce the risk of volatility in the cryptocurrency market.
The largest stablecoins, which account for around 90% of stablecoin trading today, work like this: a company that issues the stablecoin (e.g. Tether for USDT) must guarantee to have as many dollars in reserve as there are stablecoins in traffic. So, if a customer wants to sell his stablecoins for dollars, there is sure to be enough money in the coffers of this company to make this conversion. It is therefore a parity based on the stock of “real” money available to the stablecoin issuer.
Conversely, Terra USD is a stablecoin that works with the Luna cryptocurrency and cryptographic algorithms. The complex architecture of the algorithms makes it possible to maintain, thanks to the Luna cryptocurrency and a basket of currencies, the UST at one dollar… in theory.
“For example, by selling or buying luna, the algorithms will reduce or increase the price of the UST to reach parity with the dollar. When there is a big spike up or down. When there is there is a lot of demand for Terra USD and the currency basket that supports it, its value fluctuates around 1 dollar (0.9998 dollars or 1.0012 dollars), the algorithms take on the role of stabilizer”, specifies Laurent Pignot.
How to explain the fall of the stablecoin terra?
So let’s go back to what happened on Monday. For several days, cryptocurrencies have been falling, bitcoin having even fallen below the 30,000 dollar mark. The Luna cryptocurrency, the thirteenth largest cryptocurrency in the market in terms of capitalization, thus fell by 44% in one day, being worth at the time of writing this article 33 dollars.
“The demand for sales was so strong on luna and cryptocurrencies that the UST algorithms did not withstand this volatility shock”, specifies Laurent Pignot. In addition, the Luna foundation, which oversees the Terra blockchain, had bought a stock of bitcoins to be able to intervene in the event of a problem: in this context, it has just mobilized the equivalent of 1.5 billion dollars in bitcoins to bring back the ‘UST at equilibrium.
Faced with such an algorithmic flaw, the stablecoin lost credibility with its users. In the short term, “people will start to part with it due to the risk of volatility shock while stablecoins are supposed to be a store of value in the crypto ecosystem”, underlines Laurent Pignot, who thinks that users will turn to other stablecoins.
However, Terra remains a blockchain created in 2018 and which is used for certain decentralized applications, “which means that there will always be users who will need the UST to use applications. But for users who do speculation, they will turn to other stablecoins. Terra should lose a lot of capitalization in the short term”, underlines the expert.
No impact on the stablecoin market
Despite this scenario, remember that the stablecoin Terra USD represents only 1% of the stablecoin market, which currently weighs 1473 billion dollars. “The problem encountered on the UST is serious for this stablecoin and for the Luna project, but it will not have an impact on the parity of the two largest stablecoins, USDT and USDC”, explains to BFM Crypto Romain Saguy, marketing and commercial director at Coinhouse.
Furthermore, “the UST is fortunately still relatively little used in the crypto ecosystem, and in particular has no direct impact on Ethereum projects. It is likely that the project will manage to survive at least in the short term, and if we are looking for a positive point in these troubles, it is that in the end, it will reinforce the security of the entire market, either by the disappearance of a project with unstable bases, or by securing and perpetuating its functioning” emphasizes Coinhouse in a note published today.
Around 4 p.m., the Terra USD was still showing at just $0.88.
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