One shiny premise of DeFi or decentralized finance—a catch-all term for cryptocurrencies and blockchain projects related to the exchange of value—is that by spreading out and automating operations, and removing power from middlemen like banks, it can offer a system more resilient to global forces , able to survive events like war and economic downturns that pummel traditional markets. Some industry insiders have even suggested crypto could be a good investing bet to ride out a potential recession . Now in our current precarious financial climate, with the traditional market slipping dramatically and Big Tech stocks plummeting, that theory of resilience is getting a real-life road test. And the results are not great.
Bitcoin has taken its own nose dive in the past few weeks, Ethereum, and others have dipped as well. As “Web2” tech companies like Amazon and Netflix watch their stock drop, Coinbase—one of the top three crypto exchange platforms—and Robinhood—which supports crypto trading—have seen theirs falling right alongside. Even popular proof-of-stake network Solana has seen its coin drop in value by about 80% since its all-time high in November. But the big crash came last week, when major algorithmic stablecoin TerraUSD (UST) dramatically tanked. A $100 stake in UST last Monday was worth just $18 by Sunday morning ; that much in its sister token, LUNA, is worth pennies now.
Stablecoins, as the name suggests, are designed to be the rocks of the crypto ecosystem , pegged sturdily to real-world assets like the dollar. Exchanges use stablecoins to even out the volatility of other coins, and crypto investors may favor them as a safer bet to park money. They have served their function pretty well so far, although questions around consumer safety and their potential for illicit activity have certainly caught the attention of regulators .
Algorithmic stablecoins , however, are different. They are a DeFi experiment in a stablecoin that doesn’t peg itself to fiat money or hold collateral assets to stabilize its value. Instead, they are usually supported by a second token, in a push-me-pull-you math equation. Terra, for example, balances variations in the stablecoin’s value by increasing or decreasing the supply of Luna tokens through incentives; investors can profit off these exchanges, which keeps them—in theory—trading tokens in the amounts the algorithm predicts they will. But much of this is magical thinking.
Well before the Terra crash, algorithmic stablecoins were generally understood to be much less stable than regular ones . Even Sam Bankman-Fried, CEO of the crypto exchange FTX and notable “crypto billionaire”, argued on Twitter last week that the two types of stablecoins are so distinct from both a functional and risk perspective that “[r]eally, we shouldn’t use the same word for all these things.”
So why pursue algorithmic stablecoins at all? Because algorithmic stablecoins were supposed to be the DeFi holy grail: a stable unit of value that self-corrects independently and elegantly, like water naturally finding its own level. They appeal to Bitcoin purists because algorithmic stablecoins aim to avoid what regular stablecoins like Tether and USDC rely on to function: a tie to the real world and traditional markets. They operate on code alone—besides, of course, the human traders the system presumes will act in a predictable way. If algorithmic stablecoins perform as promised, they could demonstrate that code is the future of finance, lending new credibility to the crypto worldview.
For a while, it looked like Terra’s experiment might just work. In February, Terra closed a multi-million dollar sponsorship deal with the Washington Nationals. Just over two months ago in March, its blockchain—the seventh most valuable in the world at the time—became the number two staked network , unseating Ethereum. But on Monday, May 9, things went off course. Someone may have pushed UST’s value to start dropping, by acting against the algorithm’s predictions. Then the coin crashed to well below the $1 value it was designed to maintain, fueled by very human, fear-driven “bank runs.” When UST reached $0.37 on Thursday, the company that manages it, Terraform Labs, even made the last-resort call to temporarily stop transactions on its network to protect against further decline and then froze them once more overnight—preventing any token holders from taking what little they had left and running. Since the network restarted, Terra’s UST has continued to fluctuate well under $0.50; LUNA hovers just above zero.
Each company in the crypto ecosystem has its own explanation for why it’s faltering. Coinbase’s much-anticipated new NFT marketplace had an underwhelming launch at the end of April, which may […]
source Crypto is weathering a bitter storm. Some still hold on for dear life.