The cryptoverse was front page news again on Wednesday, when algorithmic stablecoin TerraUSD briefly plunged below $0.30.
To the uninitiated, that’s just indecipherable cryptospeak, but bear with me. This is a big deal.
TerraUSD is supposed to trade at $1 all the time. It’s a stablecoin. But unlike fully-reserved stablecoins, which are backed by real cash and cash equivalents, TerraUSD depends on automation, arbitrage, active management of treasury assets and incentives to maintain the peg. Its market cap was near $19 billion before the peg broke, beginning over the weekend. For those interested in more details, I discussed this at some length on Tuesday in “My Algorithmic Stablecoin Broke. Who Do I Call?”
The figure (below) illustrates the severity of the problem. The assumption of a 1:1 dollar peg underpins stablecoins’ use cases across various blockchains and decentralized finance protocols. If that assumption fails to hold or, in this case, falls apart altogether, the ripple effects could be substantial.
The market was waiting on a recovery plan from backer Do Kwon who, along with a consortium of investors, has variously pledged to help restore the peg. But to call this a crisis of confidence would be to materially understate the case.
I’d mention (only in passing, because this is a rabbit hole that most readers won’t be interested in going down) that this started with a withdrawal from Curve ahead of the planned deployment of “4pool,” a liquidity pool which Terra described early last month as “the new gold standard for stablecoin liquidity.” The pool was supposed to be composed of UST (TerraUSD), FRAX (a coin with substantial buzz) and two reserved stablecoins, USD Coin and Tether’s USDT. Frax and Terra are the two largest protocol holders of Convex, which I mentioned on Tuesday in the linked article above.
Confusion around a separate, $84 million transaction fueled intense speculation. Do Kwon confirmed that Terra withdrew $150 million from Curve “to get ready” for the deployment of 4pool, but denied any connection to the address that bridged $84 million of TerraUSD to a newly-opened Ethereum wallet, only to dump it all four minutes later, according to one researcher. “Obviously, [Terra] has no incentive to depeg TerraUSD,” Do Kwon said, on May 8.
The point in regaling readers with that delightfully obscure backstory is to underscore the fact that stablecoins are more than volatility shelters for crypto traders and NFT buyers who, for whatever reason, want to temporarily hold some of their blockchain assets in a coin that doesn’t swing wildly on a daily basis. Stablecoins serve a variety of purposes across decentralized finance and Curve is perhaps the most well-known hub for stablecoin liquidity and trading. TerraUSD’s problems, if they persist, won’t be confined to TerraUSD.
“I understand the last 72 hours have been extremely tough on all of you,” Do Kwon wrote, in a social media post on Wednesday, adding that,
I am resolved to work with every one of you to weather this crisis, and we will build our way out of this. Together. A review of the current situation: TerraUSD is currently trading at 50 cents, a significant deviation from its intended peg at $1. The price stabilization mechanism is absorbing TerraUSD supply (over 10% of total supply), but the cost of absorbing so much stablecoins at the same time has stretched out the on-chain swap spread to 40%, and Luna price has diminished dramatically absorbing the arbs. Before anything else, the only path forward will be to absorb the stablecoin supply that wants to exit before TerraUSD can start to repeg. There is no way around it. We propose several remedial measures to aid the peg mechanism to absorb supply.
He then detailed a community proposal that involves increasing the base pool and minting capacity which, he wrote, “should allow the system to absorb the [TerraUSD] more quickly.”
“Isn’t that Kwontitative Easing?”, one clever netizen wondered, in a reply. “Terra Luna has value because its supply is limited, If you bring about Kwontitative Easing (KE), what difference is there with the USD and QE?”
LUNA, Terra’s native token and an integral part of the arbitrage process, traded as low as $2.20 on Wednesday. At the highs, on April 4, it traded above $115.
TerraUSD’s market cap has fallen by some $10 billion since the peg broke five days ago. LUNA’s market cap decline over the same period comes to around $20 billion.