What happens when a “stablecoin” isn’t so stable? Investors are trying to make sense of what’s going on with a popular token known as TerraUSD, the world’s fourth largest stablecoin, which has failed to maintain its value relative to the U.S. dollar.
What is an algorithmic stablecoin?
A stablecoin is a type of cryptocurrency whose value is pegged to other assets, usually fiat currencies such as the U.S. dollar. They are designed to maintain a stable price, which makes them popular when it comes to facilitating trading, lending, and borrowing of other digital assets.
Some stablecoins, such as USDT
USDTUSD,
and USDC
USDCUSD,
are backed by reserves including U.S. dollars, cash equivalents and other assets. Others, such as TerraUSD
USTUSD,
or UST, attempt to maintain their pegs through algorithms.
What is Terra? How does it work?
Terra is the world’s largest algorithmic stablecoin and the 11th largest cryptocurrency by market capitalization as of Tuesday, according to CoinMarketCap. Terra aims to maintain a one-to-one peg against the U.S. dollar through an algorithm that controls the supply of UST and an associated cryptocurrency called LUNA
LUNAUSD,
Investors are supposed to be able to exchange one UST for $1 worth of LUNA, and vice versa. When UST is trading below $1, traders have incentive to buy one UST and exchange it for $1 worth of LUNA to make a profit. As UST is burnt to mint LUNA, the former’s supply would be reduced and its price will be pushed up. When UST is trading above $1, traders could be incentivized to exchange their LUNA for UST. As UST’s supply increases, its price would fall.
Terra grew at a breakneck speed — LUNA’s price surged from about $7 in July to an all time high of $120 in April, before it fell to $17, according to CoinDesk data. Anchor, a popular lending application on Terra that pays interest of up to 20% on crypto deposits, saw the value locked on the protocol up from $1 billion in July 2021 to a peak of $17.2 billion on May 5, before it fell to $5.9 billion on Tuesday, according to data from DefiLlama.
Why is Terra in the news?
TerraUSD briefly fell to around 99 cents on Saturday, before it climbed back to $1 on Sunday. On Monday, the stablecoin lost its peg again, falling to as low as 61 cents on crypto exchange Binance. It is recently trading at around 79 cents, well below the crucial $1 level.
Luna also plunged, with its price down about 50% over the past 24 hours to around $16, according to CoinDesk data. The token’s market capitalization has shrunk from more than $29 billion seven days ago to about $6.5 billion, according to CoinGecko.
What’s the impact on the crypto ecosystem?
Investors are worried the fall of UST may add to selling pressure on bitcoin
BTCUSD,
which is already trading at a 10-month low. Some…
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