Stablecoins are cryptocurrencies that are known as pegged to the US dollar, and their market value has been expanding over the past few years, and the risk of decoupling the US dollar has always been like an "elephant in the house". But now, this risk has truly erupted, and a "currency disaster" has followed, which may even endanger the stability of the traditional financial system.
On Thursday, the third largest stablecoin, the "algorithmic stablecoin," UST, and its sister token, LUNA, suffered a "death stampede," which was supposed to be anchored at $1 but plummeted to 26 cents, leaving only a pitiful 0.09 cents on Monday. After the value of the LUNA coin once evaporated by 99%, the first stablecoin, the "guaranteed stablecoin", USDT, fell below the $1 it should have anchored, and at one point fell below 95 cents. The price of Bitcoin was again pushed down to a new 16-month low. As of 16:40 Beijing time on May 16, the price of a bitcoin was $29,829, falling below the $30,000 mark, down from the high of $70,000 at the end of last year.
Previously, it was also reported that LUNA and UST had exhausted all the funds of Jump Crypto, and investors may demand redemption and liquidation. The point is that Jump Trading, where it is located, is the largest market maker of nasdaq ETFs. Cryptocurrency investment management firm Galaxy Digital was also exposed to risks, which exacerbated Nasdaq's decline last week.
UST, LUNA caused "coin disaster"
"Fortunately, I don't have much UST, but it did go to zero overnight." A cryptocurrency exchange person told reporters.
Another institutional source said: "A fund managed by a friend is close to zero. Originally the income was good, lying equal settlement, the result was put in the UST and shot. ”
The collapse of stablecoins clearly impacted the entire coin circle. Bitcoin fell below the $30,000 mark last week, falling as low as $29,735 on May 11, a drop of more than 10 percent in 24 hours.
Specifically, as an "algorithmic stablecoin", UST is not backed by the equivalent amount of DOLLAR assets like mainstream stablecoins such as USDT and USDC. UsT's stability comes from the mutual conversion and arbitrage space of the two Terra blockchain tokens. Among them, LUNA is the native token of Terra public chain, its price is not stable, and UST is the algorithm stablecoin of Terra public chain, which is the "legal tender" of Terra ecology. When the price of USD exceeds $1, the holder of LUNA can exchange their hand for LUA at the exchange rate of $1 to USD at any time and sell it at market price. In the process, LUNA was destroyed and UST was minted. As the supply of UST in the market rises, the arbitrage mechanism drives the UST price back to $1. When the price of USD falls below $1, the holder of UST can always mint the UST in his hand back to LUNA at the price of $1 and sell it for a profit. In the process, the supply of UST in the market will decline, and the arbitrage mechanism will drive the price of UST back to $1.
While the market is booming, this upward spiral is played with. Because when the UST price is higher than $1, due to the continuous purchase of LUNA to arbitrage, the LUNA price will continue to rise, funds will continue to flow in, and the supply of UST will continue to rise. However, when the UST price falls below $1 and there is a delay in returning to $1, the arbitrage of minting UST back to LUNA at $1 will cause the supply of LUNA in the market to rise sharply, causing its price to fall. The lower the LUNA price, the more it is needed to destroy the UST to generate LUNA, which will further depress the price of LUNA.
Last week, UST kept trading below $1, losing investor confidence in stablecoin issuer Terra and exacerbating the UST's sell-off. Eventually, the prices of UST and LUNA may both go to zero. This risk has been triggered.
"UST's market volatility in recent days has exacerbated the decline of LUNA, which in turn has led to a serious de-anchoring of UST, which has made a large number of runs occur, and UST has officially stepped into the 'death spiral'." Zhao Wei, a senior researcher at the Ouyi Research Institute, told reporters that the Federal Reserve released its latest Financial Stability Report on Monday and emphasized the risk of a run on stablecoins. The data shows that UST has been decoupled from the dollar twice in just 3 days. At the same time, Coinbase, the largest digital currency exchange in the United States, has experienced a long period of negative premium on the price of stablecoins, and the outflow of funds is obvious. Stablecoin issuers continue to reduce their issuance to stop the decline in coin prices, proving that market demand is declining.
According to the reporter's understanding, there are also exchanges that take early remedial measures. For example, since the LUNA price fell to 65 USDT on May 8, the UST price first appeared briefly decoupled, and after triggering the risk control system, Ouyi OKX has launched an automatic redemption mechanism to redeem all the user's assets from the chain for issuance. The incident involved tens of thousands of users, and when redeemed, the UST price was 0.996 USDT, which basically avoided the overnight clearance of the account. But most of the HOLDERS of THE UST still suffer losses. Cryptocurrency exchanges Binance and FTX have suspended trading, Binance last week announced the suspension of LUNA, UST redemption, network congestion and the suspension of derivatives trading, the entire virtual currency system funds and confidence are evaporating.
Stablecoins raise concerns about financial risks
In fact, the market value of the "algorithmic stablecoin" UST is small, and the overall impact is controllable, but if it is a USDT such as a "guaranteed stablecoin", it will also expose the same risk, which will have a relatively large impact on financial stability.
A "secured stablecoin" is a reserve fund that is collateralized by assets such as U.S. dollars or U.S. treasuries to support the price of a stablecoin. In the case of USDT, for example, most of the USDT is issued in the form of tokens on the Bitcoin blockchain through the Omni Layer protocol, and each issued USDT is pegged to $1, and this portion of the DOLLAR is deposited in Tether. Upon redemption, usdt holders can exchange USDT for fiat or bitcoin.
In fact, the question of "secured stablecoins" has never been interrupted, especially Tether has never publicly proved whether for every stablecoin issued, there is a corresponding $1 mortgage. And USDT's relationship with Bitfinex, the world's largest bitcoin exchange, has also become the focus of doubt. According to public information, TETHER, the issuer of USDT, was founded in the British Virgin Islands by Bitfinex's Chief Strategy Officer and Chief Financial Officer, and Tether and Bitfinex's CEO, CFO and Chief Strategy Officer are highly aligned. In other words, a big reason why investors holding USDT continue to "buy it" is the belief in Bitfinex's ability to redeem as the world's largest bitcoin exchange. But once this "consensus" is broken, it is clear that the value of the "guaranteed stablecoin" is no longer stable.
Holders of stablecoins fear that they will not be able to convert stablecoins into fiat when risk arises, and investors try to cash out quickly. In order to meet the demand for redemption, the issuers of stablecoins will have to sell assets that support the value of stablecoins, which will lead to a massive sale of safe assets such as US Treasuries, hurting a key part of the financial system. At a Senate hearing in Congress on May 10, U.S. Treasury Secretary Yellen said legislation on stablecoin regulation was imminent and that the Financial Stability Regulatory Commission (FSOC) was trying to identify the risks that those digital assets would pose.
Traditional financial markets also need to be vigilant
It is not difficult to find that if "guaranteed stablecoins" such as USDT are forced to decouple, the US Treasury bond and commercial paper markets may also be affected. Shocks in U.S. stocks are also inevitable, "Last week's UST crash clearly led to an expansion of the NASDAQ index's decline. An investment manager of a US small and medium-cap growth fund told reporters.
Industry insiders told reporters that Tether had not provided the promised audit report to the government earlier, so there was not enough evidence to show that there were enough reserves to support Tether tokens. The U.S. Commodity Futures Trading Commission fined Tether $41 million in October 2021 for allegedly misreporting its reserves. There have also been reports of Tether funds flowing from Taiwan to Puerto Rico, France, the Bahamas and other countries.
In addition, Tether has been making potential profits for itself by investing in reserves, which is also extremely risky, and it disguises itself as a high-risk offshore hedge fund. In 2021, it was reported that about $30 billion of its U.S. dollar assets were invested in commercial paper, among other things, which would make Tether the seventh-largest holder of such debt, close to parity with prominent fund firms Charles Schwab and Vanguard. For now, USDT's market cap continues to inflate. Previously, Bloomberg reported that Tether's asset audit was a rough estimate, and the worst case scenario was that its assets did not exist at all. If the asset reserves behind USDT are not sufficient, this is a very dangerous move that could lead to a collapse of the entire USDT, which will have a negative impact on Bitcoin, as 70% of Bitcoin transactions are done using USDT.