The not-so-stable stablecoin economy

Last week, we got a stark reminder of the volatility of cryptocurrencies.

Bitcoin plummeted to its lowest value in 16 months. This time, the source of the cascade of selling came from an unexpected quarter.

The market crashed after investors fled a type of crypto called stablecoins, whose worth is pegged to a traditional currency, like the U.S. dollar. Meaning one stablecoin should equal $1 in value — the emphasis being on “should.”

Last week, that kinda fell apart.

Emily Nicolle is a crypto blogger for Bloomberg. She said stablecoins are meant to stay put at a certain value because they have reserves to back them up. The following is an edited transcript of Kimberly Adams’ conversation with her.

Emily Nicolle: Most stablecoins do that by having a large reserve in place of dollarlike assets, whether that’s real dollars or dollar equivalents. But in the case of some unique experiments, they can use algorithms and swaps with other crypto tokens to try and keep that peg in place.

Kimberly Adams: And so last week, we heard a lot about tether and terra[USD]. What’s the difference between these two cryptocurrencies?

Nicolle: Tether has a large reserve of dollar and dollar-equivalent assets. Terra, on the other hand, uses a complex system of algorithms and trader incentives to adjust its supply and maintain its peg with the dollar. It has a sister token called luna, and basically swapping itself between the two it can try and stay at the value of $1.

Adams: The cryptocurrency with which most people, I think, are familiar is bitcoin. As you looked at the ripple effects through the market last week, how did it affect that currency?

Nicolle: As the terra collapse started to become very apparent, it caused a knock-on effect across a lot of the crypto market. Bitcoin was down below the $30,000 mark, which is pretty low considering summer last year, it got all the way up to, you know, almost $70,000. And looking at what bitcoin looks like now, and today, at the time of recording, it’s still pretty much struggling below the $30,000 mark, which is causing investors some concerns because a lot of what traders are thinking about is trying to predict where bitcoin might go in terms of price and how that might affect their portfolio later.

Adams: We’ve seen a lot of volatility in the crypto space in the past. Is this crash any different, and if so, what makes it?

Nicolle: This time is quite different because terra and luna itself, those two tokens, they were part of a massive project that had really become a very key part of the crypto ecosystem over the last year. People put their money in that because they think it’s a safeguard from the volatility of the rest of the crypto industry. And they expect that to hold its price. They don’t expect that to be something that goes up and down. It’s almost like a savings account. You might put a lot of money in that intending to trade it somewhere else at some point, but it’s kind of your, like, your backstop. And so that’s why this is such a damaging part of crypto to go wrong.

Adams: Well, that leads me kind of to my next question, what are some of the lasting consequences of a crash like this?

Nicolle: So if we think about the immediate consequences, a lot of investors are very hurt at the moment. A lot of people will have put a lot of money into this project, a lot of savings, and they now no longer have those ⁠— everything has gone to zero, and they feel betrayed by that. And in terms of kind of reparative steps, a lot of people are looking to the bodies that were built up around the terra ecosystem to try and recover some of that value or rescue their portfolios.

Adams: And in terms of who this is affecting, was there a typical terra investor? Who’s lost their money here?

Nicolle: Given that the project was in relatively early days compared to something like bitcoin or ethereum, a lot of the investors in terra or luna would be people who are more in tune with the space. They were looking at what would be the next thing to buy. And so they would be, I guess, more experienced investors, than, you know, your regular trader on the street. However, especially in the last year, the project itself was getting a lot of press. It was becoming very much a household name, in the crypto world anyway. And so it would be very likely many of them in the crypto space would have held at least some terra or luna in their portfolio.

Adams: What kind of regulatory response are you seeing from governments in the wake of this crash, and as this situation continues?

Nicolle: Prior to this crash, they were already looking at stablecoins as a threat because these are systems that they can’t control and they don’t necessarily have all the oversight for. What this has done is basically give regulators a lot of fuel for their fire. Terra was an extremely experimental project because it relied on algorithms rather than assets. And so it’s definitely given regulators a lot of food for thought as to actually how they might need to expand what they were planning to do for stablecoins to include these sorts of projects. And also crack down even further on projects that are collateralized like tether to really show, you know, these are the assets we have in the bank that could support this because that’s something that has been missing so far. It’s the transparency.

Related links: More insight from Kimberly Adams

For Bloomberg, Nicolle reported an initial story when tether lost its dollar peg and another article that includes what academics and traders are thinking about the future of stablecoins after this latest drama.

And if you’re still trying to make sense of the difference between terra and tether, and what exactly luna is, you’re not alone.

The Wall Street Journal has an explainer that helped me get familiar with the nuances.

Also, we wondered, what happens to stablecoins now?

Well, Fortune has a story all about terra’s stablecoin and the plans the company behind the coin has to scrap the token and build a new blockchain.

Because terra’s token is still valued at less than a dollar. Much less. As we’re recording this, it’s worth about 12 cents.