A sell-off in a cryptocurrency believed to be pegged to $1 accelerated on Wednesday, briefly sending its price below a quarter of that value.
TerraUSD traded as low as 23 cents on Wednesday, according to data from CoinDesk. By 5 p.m. ET, it had partially rebounded to around 67 cents in volatile trading.
A stablecoin, this breed of cryptocurrencies had gained favor with traders for being the only part of the crypto universe that was known for its stability. While the most popular stablecoins maintain their levels with assets that include dollar-denominated debt and cash, TerraUSD is what is known as an algorithmic stablecoin, which relies on financial engineering to maintain its link to the dollar.
TerraUSD’s peg break began over the weekend with a series of large TerraUSD withdrawals from Anchor Protocol, a sort of decentralized bank for crypto investors.
Anchor Protocol is built on technology from the same Terra blockchain network that TerraUSD is based on. This had been a major factor in the growth of the stablecoin in recent months by allowing crypto investors to earn returns of almost 20% per year by lending their TerraUSD holdings.
At the same time, TerraUSD has also been sold for other traditional asset-backed stablecoins through various liquidity pools that help peg stability, as well as through cryptocurrency exchanges. The sudden outflow of silver spooked some traders who started selling TerraUSD and its sister token Luna. Before its peg was broken, TerraUSD was the third-largest stablecoin, with a total market value of $18 billion.
TerraUSD’s drop to 23 cents around 3:30 a.m. ET marked a 70% drop from its value 24 hours earlier, according to CoinDesk.
Even though TerraUSD started to recover after hitting its low, Luna continued to fall. The token was down around 95% from the previous 24 hours around 5 p.m. ET, trading at $1.16.
“I understand that the last 72 hours have been extremely difficult for all of you – please know that I am committed to working with each of you to overcome this crisis, and we will get through this,” wrote Do Kwon, the Southern Developer. Korean who created TerraUSD, on Twitter on Wednesday.
Stablecoins have grown in popularity over the past two years and now act as the grease that keeps the gears of the cryptocurrency ecosystem moving. Traders prefer to buy coins such as bitcoin, ether, and dogecoin using dollar-pegged digital assets because when buying or selling, the price only moves one way. They also allow for fast trading without the settlement times associated with government-issued currencies, which can take days.
The price of bitcoin fell to $28,314.54 on Wednesday, down 8.5% from its level at 5 p.m. ET on Tuesday. It has lost around 28% of its value in the last 7 days. It has lost around 24% of its value in the past week alone.
In the past, TerraUSD maintained its $1 price relying on traders acting as its backstop. When it fell below the peg, traders would burn the stablecoin – removing it from circulation – by trading TerraUSD for $1 worth of new units of Luna. This action reduced the supply of TerraUSD and increased its price.
Conversely, when the value of TerraUSD exceeded $1, traders could burn Luna and create new TerraUSD, thereby increasing the supply of stablecoins and bringing its price back towards $1.
Such a model has drawn criticism because it relies on the collective will of people to support cryptocurrency. Without it, the stablecoin can sink quickly, in what industry players have described as a “death spiral.”
Martin Hiesboeck, head of blockchain and crypto research at digital currency platform Uphold, likened what’s happening with TerraUSD and Luna to a bank run. “People don’t trust him anymore, they run for the exit,” he said.
Mr. Kwon, the creator of TerraUSD, also co-founded the Luna Foundation Guard, a non-profit organization that helps support TerraUSD and keep it anchored.
Earlier this week, the foundation said to have loaned $750 million of bitcoin to trading companies to protect the peg of the stablecoin. Blockchain records from the foundation’s wallet show that it no longer holds any bitcoin in that account.
The day before, the value of TerraUSD rebounded to around 90 cents after falling to 61 cents, while Luna also rallied after plunging.
Sen. Pat Toomey (R., Pa.), the top Republican on the Senate Banking Committee and an enthusiastic proponent of cryptocurrencies in Congress, told reporters on a conference call Wednesday that the sale of Terra has refocused the attention from lawmakers on stablecoins.
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