The UST crash is destabilizing crypto

The sudden collapse of Terra’s UST and luna coins will trigger more crypto scrutiny.

Falling crypto tokens.

The UST and luna collapse strengthens the view that the design of some stablecoins poses serious risks.

Illustration: Christopher T. Fong/Protocol

The collapse was stunning, a bank run that happened with lines of codes, not sidewalks crowded outside a branch.

From $30 billion just last week, the luna cryptocurrency’s market value plunged to $79 million this week. Its sister stablecoin, UST, which is supposed to be pegged one-to-one to the U.S. dollar, plunged below 37 cents Thursday.

The crash was the kind of risk in the fast-growing crypto market that regulators have been warning about. It also brought renewed attention to the role of stablecoins in an increasingly unpredictable space.

Stablecoins are supposed to offer a safe way for crypto users and investors to trade in and out of volatile cryptocurrencies. But the UST and luna collapse strengthens the view that the design of some stablecoins poses serious risks.

Algorithmic stablecoins like UST, backed by automated software meant to maintain a dollar peg rather than reserves, are particularly troubling to some observers.

“I see these instruments as incredibly opaque rather than transparent,” Bill Nelson, chief economist of the Bank Policy Institute, told Protocol. “They end up being held with a lot of leverage and that's where the danger comes.”

“All stablecoins are not created equal,” said Steve Ehrlich, CEO of Voyager Digital. “There’s a significant difference between what Terra was trying to achieve — an algorithmic stablecoin based on crypto-backed collateral — than with a fiat-backed stablecoin, like USDC for instance, backed by U.S. dollars and U.S. treasuries,” he told Protocol.

UST relies on algorithms that dynamically seek to control the supply of UST and luna to maintain the stablecoin’s value at $1. The price of luna floats freely, like other cryptocurrencies, but is designed to be exchangeable for UST on a dollar-for-dollar basis.

However, Alex Johnson, author of the Fintech Takes newsletter, said many stablecoins also promise to generate a return for holders. Stablecoin companies, he argued, should act more like the Federal Reserve by providing a highly stable asset, not high yields: “Your job isn't to build algorithms that dynamically reprice assets. Your job is just to have $1 in the bank for every dollar of stablecoins.”

UST offered 20% returns to users who deposited them in Anchor, a “savings protocol.”

In a way, stablecoins may have become riskier precisely because they are perceived to be safer than bitcoin and other cryptocurrencies.

The UST collapse is bound to bolster the push to regulate crypto, specifically stablecoins.

Republican Sen. Pat Toomey recently proposed the Stablecoin TRUST Act, which would spell out rules for stablecoins.

“These are investments that can sometimes [have] tremendous returns, but they can also go to zero,” Toomey said in a call with reporters on Wednesday. “So investors should always make sure they understand what they're investing in.”

Johnson said the UST crisis will likely also put “more wind in the sails” of the push for a central bank digital currency, also known as the digital dollar.

“Stablecoins did demonstrate a real market need,” he added, but it’s not clear the private sector is best suited to fill it.

Washington is divided on the digital dollar. Rep. Tom Emmer has called the idea a path to “digital authoritarianism,” and has introduced a bill to prevent the Federal Reserve from issuing digital currencies directly to individuals. Researchers, however, believe that a privacy-preserving CBDC is possible. The Fed is still studying the issue.

So the government is going slow while the crypto markets move with a viciously Darwinian speed. There’s likely to be more damage ahead.


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