Destruction of TerraUSD the third largest stablecoin has commenced

In the crypto world this week, all that matters is the implosion of one of the world’s largest crypto projects. In 2021, TerraUSD ($UST) quickly became one of the world’s largest stablecoins — but now its fall might come even faster.

Stablecoins are one of the biggest innovations in crypto — a stable digital currency with cheap transfer fees which (mostly) trades close to $1 with minor fluctuations of a couple of cents.

What happens when stablecoins become unstable?

Historically, they fail — a fate TerraUSD is facing. This week, UST fell below its $1 peg, dropping as low as 30 cents and panicking the crypto world.

• Bank run: People rushed to cash out their UST — which led to its market supply falling from over $18B to nearly $4B at the time of writing.
• Collateral damage: UST maintained its peg using its sister token Terra ($LUNA), and given its algorithmic relationship, $LUNA also collapsed.

In 2021, Terra’s ($LUNA) price soared over 140x — propelling it into the top 10 tokens with a market cap of over $41B at its peak. In just a week, $LUNA fell 99.9% from $83 to under 3 cents.

Many in the industry call this a targeted attack on TerraUSD — whose perpetrators likely profited from its collapse.

The “Lehman moment” of crypto

The team is pulling out all the stops to save UST — implementing emergency actions to stabilize the token. UST backers tried to raise $1.5B in the past few days with a cold reception from investors.

• If they fail, UST will be joining the graveyard of failed algorithmic stablecoins.
• “This is crypto’s Bear Sterns/Lehman Brother’s moment,” without a government bailout — per Will Clemente, Blockware Solutions Analyst (The Defiant).

The contagion briefly spread to Tether ($USDT) — the largest stablecoin by market cap — which broke from its peg, falling to $0.95 before recovering.

UST’s collapse sets the entire industry back, and it will be difficult to recover from this. UST/Luna has lost investor trust — and investors are now questioning whether algorithmic stablecoins have a future.

Investors: It’s all an experiment

Tether and USD Coin are collateral-backed stablecoins — meaning they can be exchanged one for one with another asset (i.e., bonds/USD).

But UST is an algorithmic stablecoin — which uses algorithms (and its relationship to $LUNA) to maintain its $1 peg. Algorithmic stablecoins are a significant opportunity — but getting it right has been difficult.

After this whole incident, regulations are likely to become a big focus among lawmakers:

• Shortly after UST’s depeg, Janet Yellen called for regulations on the $180B stablecoin industry.
• According to two former SEC lawyers (The Block), the SEC is likely already investigating the UST events.

Reminder: Crypto is still a big experiment, and anything can still go to zero — even the largest projects.