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Stablecoin TerraUSD Continues Downward Spiral; Bitcoin Profits

Major cryptocurrencies showed signs of recovery after a roughly week-long sell-off, while battered stablecoin TerraUSD continued to tumble.

Bitcoin rose about 4.3% on Friday from its level at 5:00 p.m. ET on Thursday, trading around $29,800.33 after falling below $26,000 on Thursday. Ether, the second largest cryptocurrency by market value, rose 6.2%.

TerraUSD fell to 10 cents early Friday after falling 82% over the past 24 hours, according to CoinDesk. In the late afternoon it rose to around 14 cents. The formerly third-largest stablecoin — a type of cryptocurrency known for its stability — broke free from its $1 peg after a sell-off that began over the weekend. Its demise has taken its sister token Luna with it, weighing on bitcoin. Luna fell to less than half a cent on Friday, from more than $60 on Monday.

The blockchain underlying TerraUSD and Luna has been halted twice as their network validators try to stabilize the digital assets. Binance, the largest cryptocurrency exchange by volume, suspended trading in TerraUSD and Luna late Thursday.

On Friday, both blockchain and Binance trading resumed on TerraUSD and Luna, according to the companies.

Stablecoins have grown in popularity over the past two years and are now acting as the lubricant that turns the cogs of the cryptocurrency ecosystem. Traders prefer to buy coins like bitcoin, ether, and dogecoin with digital assets pegged to the dollar because the price only moves to one side when buying or selling. They also allow for quick trading without the settlement times associated with government-issued currencies, which can take days.

While the most popular stablecoins hold their ground with assets that include dollar-denominated debt and cash, TerraUSD is an algorithmic stablecoin that relies on financial engineering to maintain its connection to the dollar.

Historically, TerraUSD maintained its $1 price by relying on traders to act as a backstop. When it fell below the peg, traders burned the stablecoin — and removed it from circulation — by exchanging TerraUSD for $1 worth of new Luna units. This action reduced TerraUSD’s supply and increased its price.

Conversely, if the value of TerraUSD surged above $1, traders could burn Luna and create new TerraUSD, increasing the stablecoin supply and lowering the price back towards $1.

This financial technique for maintaining their bond faltered over the weekend with a series of large withdrawals from Anchor Protocol’s TerraUSD, a sort of decentralized bank for crypto investors.

Meanwhile, TerraUSD has been sold for stablecoins backed by traditional assets through various liquidity pools that help peg stability, as well as cryptocurrency exchanges. The sudden outflow scared some traders who started selling TerraUSD and Luna.

The prices of many cryptocurrencies have fallen sharply in the past week.


Photo:

Erhan Demirtas / Bloomberg News

A reserve fund of about $3 billion in bitcoin and other cryptocurrency resources held by the Luna Foundation Guard has been largely depleted in an emergency effort to rescue TerraUSD, according to the fund’s data dashboard. The sale of the fund contributed to a sharp drop in the price of bitcoin earlier this week, analysts and traders said.

write to Caitlin Ostroff at [email protected]

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Appeared in the May 14, 2022 print edition as “TerraUSD Left Out As Crypto Stabilizes”.

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