Terra (LUNA) encountered a massive 50% pullback today harming its UST stablecoin ecosystem.

Bitcoin
Bitcoin and Crypto Market Watch Tuesday, May 10, 2022 - 18:42

Bitcoin (BTC) slumped to its lowest level since May 2021 on Monday in conjunction with the US equity markets with S&P 500 smearing the space with bearish sentiments. BTC tumbled by more than 10% to briefly drop below $30,000. To put things in perspective, BTC has lost around $10,000 in a span of 5 days, sending the majority of crypto assets on a selling spree. While the market selloff is correlated with the tightening of the monetary policy by the U.S. Federal Reserve, it looks like there’s more to this than meets the eye. In today’s article, we will dissect the story behind the BTC pullback and the possible implications for the crypto market in the near future.

Who’s responsible?

Apart from the weakening economy, the depegging of algorithmic stablecoin TerraUSD (UST) over the course of three days is thought to be behind the selloff. An algorithmic stablecoin, unlike stablecoins like Tether (USDT) which are backed by U.S. Dollar and other reserves, maintains its constant value with the help of computer code (algorithm). A depegging event means the stablecoin has lost its ability to maintain value against the currency it is pegged to. UST, the dollar-pegged stablecoin behind the Terra blockchain, got depegged twice over the past few days and is currently hovering around $0.90 to the dollar. One of the main reasons for the de-peg is the sell pressure created by huge UST withdrawals from the decentralized exchange Curve along with market dumping on big centralized exchanges.

In an attempt to correct the pegging of UST to $1, Terraform Labs (TFL), the organization behind the UST, crypto asset LUNA and Luna Foundation Guard (LFG), liquidated its BTC reserves (42,530 Bitcoins) that were worth $1.3 billion as of yesterday.  Terraform Labs announced earlier this year that it planned to obtain $10 billion in bitcoin for reserves to “open a new monetary era of the Bitcoin standard.” The funds were supposed to be held in a treasury to back UST in a decentralized foreign exchange reserve to keep the value of the stablecoin at a fixed rate.

While the majority of market participants observed this offloading by TFL as a market dump, the project’s founder, Do Kwon, persuaded investors to perceive this as a way to increase liquidity around the dollar peg rather than TFL trying to exit BTC’s position. Though global cues like interest rate hikes played a significant role in the panic sell, it's hard to rule out TFL’s role in this.

What happens now?

As long as demand for LUNA exists, UST can go back to its $1 peg. LUNA is a deflationary asset that generates yield based on applications within the network. With more partnerships and utility coming in, LUNA is more likely to have buyers. There has been interest from venture capitalists (VCs) like Jump Crypto and Three Arrows Capital who are likely to protect their investments by buying near the floor (area of buying interest). Additionally, TFL has bought billions of Bitcoin and other crypto to support other alternative redemption models. This means that 1 UST can be redeemed for BTC worth $1 in the future even if the peg breaks. Also, LUNA and UST have faced such situations before 2021 when the ecosystem had far less arsenal to tackle depegging events and survived.

Implications

This phenomenon could spark an aversion in investors for algorithmic stablecoins which are under-collateralized. While UST can recover its peg in a couple of days with intervention from TFL and other major investors, it is likely to be viewed with suspicion over the coming months. It is noteworthy that fully-backed and over-collateralized stablecoins like USDC and DAI withstood such pressures earlier and remained pegged to $1.

The market cap of crypto will remain muted in upcoming months if the use of some stablecoins decline. On the brighter side, this will redirect investors to look at projects with long term potential rather than going behind well marketed ideas.

Some analysts are predicting that investors will redirect most crypto capital to Bitcoin in coming weeks (for example El Salvador bought 500 BTC yesterday) and help it recover back to $40,000 – the wider crypto market will also follow suit from there.

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Disclaimer: This article was authored by Giottus Crypto Exchange as a part of a paid partnership with The News Minute. Crypto-asset or cryptocurrency investments are subject to market risks such as volatility and have no guaranteed returns. Please do your own research before investing and seek independent legal/financial advice if you are unsure about the investments.

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