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Scared by the stablecoin collapse, investors are fleeing

The collapse of the stablecoin TerraUSD may have claimed another casualty: the staking and lending platforms at the heart of decentralized finance (DeFi).

The algorithmic stablecoin, dubbed UST on exchanges, lost its dollar peg and started collapsing this weekend, sparking panic across the cryptocurrency market. Total capitalization has fallen by half a trillion dollars since May 5, from about $1.8 trillion to $1.3 trillion on May 13, briefly erasing all of Bitcoin’s 2021 gains.

While both the market and BTC – which is back above the psychologically important $30,000 mark – are improving, the damage to DeFi lending, which has been the core use of the UST stablecoin, appears to have been greater. And it’s not yet clear how long the recovery will take.

See Also: PYMNTS DeFi Series: What is Yield Farming and Liquidity Mining?

DeFi is measured in Total Value Locked (TVL), which refers to the value of the various cryptocurrencies locked into various lending and staking pools to be borrowed or used as automated market-maker pools on decentralized exchanges.

That has slumped over the past week, falling from $261 billion a week ago to $146 billion on Friday (May 13), down about 45%. While much of this can be attributed to the plummeting value of the locked tokens themselves as the market crashed, it’s worth noting that crypto’s market cap is down just 28%.

This points to a mass exodus from DeFi that cannot be explained by the market crash or even the outright destruction of the Terra token known as LUNA, which has been paired with UST in an arbitrage mechanism used to mint the algorithmic stablecoin bound to keep at $1. Luna is now practically worthless.

But even taking all of this into account, $87 billion was withdrawn from DeFi in a single week, a mass exodus.

“Will the market be spooked by what is happening with Terra? The answer is yes,” Craig W. Johnson, chief market technician at Piper Sandler, told Bloomberg News. He compared DeFi to money market funds, adding: “Money market funds are important for investors and right now we are challenging the third largest money market fund in cryptoland.”

No one expected a major stablecoin like UST — which was #3 by market cap at $18.6 billion just a week ago — to break the buck, he said, adding, “It clearly has.”

This creates a “knock-on effect,” said Hugo Rogers, chief investment officer at Deltec Bank & Trust.

Crypto investor Aaron Brown wrote on Bloomberg Opinion: “UST collapse erodes confidence in all liquidity protocols.”

Referring to Aave, the largest DeFi lending protocol with $13.1 billion TVL, he added, “If UST can fail, maybe Aave can too. Similar to the failure of Bear Stearns, people’s attention was drawn to whether Lehman would fail.”

The question isn’t really whether DeFi will come back. After all, there’s plenty of money to be made, with interest rates — or “yields” in crypto terminology — ranging from 5% to 8% on even the most conservative DeFi lending protocols, not to mention the centralized exchanges like Coinbase and Kraken that support it Allowing users to wager their funds while remaining locked in the far safer custody of exchanges.

And many smaller tokens offer far higher yields – Kraken is currently offering up to 23% on certain tokens.

But to what extent and how quickly DeFi comes back depends on how quickly people return to a risk appetite that is declining even in the broader markets.

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NEW PYMNTS DATA: THE TRUTH ABOUT BNPL AND STORE CARDS – APRIL 2022

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