The collapse in the value of two cryptocurrencies linked to South Korea’s Terra blockchain has sent the crypto world aflutter. The resultant crash wiped out over USD 15 billion in cryptocurrency value, raising questions about the level of stability offered by “stablecoins” and attracting the attention of politicians and regulators worldwide. Jake Lee, chief strategy officer of Gopax, a South Korean cryptocurrency exchange, who knows the players involved, shared his insights at the recent Finverse Forum conference in Luxembourg.
Given the high level of interest in all sorts of digital assets and crypto-assets such as blockchain and cryptocurrency in the Luxembourg financial centre, as evidenced by the high frequency of well-attended conference sessions on the subject and extensive media coverage, the news of this downfall reverberated here. In a recent survey by Luxembourg House of Technology, or LHofT, and PwC Luxembourg, some 61 percent of respondents said they “are already assessing, developing or providing crypto-asset products/services.”
Stablecoins are a subset of cryptocurrencies that are designed to hold steady in value, through a variety of means. Stablecoin TerraUSD, known as UST, was designed to be worth 1 US dollar at all time. It “stability” was based on algorithms linking its value to that of the Luna cryptocurrency. Both Luna and UST were owned by South Korean firm Terraform Labs.
UST was de-pegged from the US dollar on 9 May and has since fallen as low as 7 and a half cents. Luna is trading for a tiny fraction of a cent after having had a market capitalisation of over 40 billion dollars. These losses have had an effect on the whole cryptocurrency market, speeding up the loss of some 300 billion dollars in value in the crypto economy.
‘Eye-popping credit yield’
Lee explained how the two Terra cryptocurrencies allowed exchanges enabling arbitragers to make 10 percent profits. These arbitragers were also able to use the “anchor protocol”, a savings, lending and borrowing platform built on the Terra blockchain, to get a 19.5 percent per annum yield.
“Needless to say, this eye-popping 19.5 percent credit yield caught the eye of many people who were looking for investment opportunities,” said Lee. “And this led to a massive, massive expansion in the popularity of UST and thus Luna.”
The collapse was linked to the actions of a few concentrated players known as “whales” who “buy a lot of UST, buy a lot of Luna, and then they dump it at the same time.”
A major hurdle was a 100 million dollar limit on the amount of UST that could be “burned” every day. One this was hit, the dumping of both cryptocurrencies increased. Efforts by the Luna Foundation, created and funded by Terraform Labs to support the Luna cryptocurrency, were inadequate. When that failed, Lee explained that Terra kept pumping more and more Luna to buy UST, leading to the crash.
Terraform Labs CEO Do Kwon has recently taken steps to ditch the UST stablecoin and create a new blockchain to resurrect Luna, but is facing a lot of angry investors.
Regulators paying more attention
“The regulators are going to be much more interested now than before in crypto,” said Michael Jackson, chairman of Arcane Crypto AS, at the conference.
Lee had warned of an “onslaught of regulation” and suggested that there may be an element of overreaction. He pointed to US Treasury Secretary Janet Yellen referring to the UST breakdown while calling for stablecoin rules, highlighting to the risk of financial instability and other moves by US regulators.
For Jackson, the increased regulatory attention is not a bad thing. “Traditional investors, banks, financial institutions, high net worth wealth managers, they can’t interact with things that are not regulated.”
Stablecoin ‘cleaning’ expected
Jackson spoke of the emergence of a new class of “regulated crypto assets that people from financial institutions are allowed to invest in, that they trust, and they want to invest in.”
Alexander Tkachenko, CEO and founder of VNX, a Luxembourg fintech regulated in Liechtenstein, highlighted the various ways in which that stablecoins are structured to be stable. He said he expects a “cleaning” or at least “a distinction” between stablecoins “with sufficient backing”, such as with USD Coin, USDC, or his own cryptocurrency VNX Gold, “or some other stablecoins that are of questionable value, or that have questionable reserves,” he said.
Tkachenko said he was “a little bit worried” about regulatory overreach. “What I’m afraid of is over-regulation, because overregulation actually kills innovation.”
Window of opportunity
Youngjun Jang, the co-founder and general partner of investment firm Edimus Capital, said the period before the arrival of new regulations could provide opportunities and said he expects the next six months or a year will continue to see “a very volatile market”.
Lee dismissed those who described the UST/Luna crash as a “black swan”. “Many professional traders soon saw the vulnerabilities that existed in the system, as it started up and gained popularity with the 20 percent yield. And I think there are several parallels in history that educate most sophisticated traders that this sort of collapse can happen.
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