How $60 Billion in Terra Coins Went Up in Algorithmic Smoke

2 Jun 2022

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If you put $1 under your mattress, you know you’ll get $1 back when you go looking for it. When you deposit $1 with a bank, you can be pretty sure you’ll get it back even if they do more with it than lock it in a vault, thanks to regulations developed over centuries. A branch of cryptocurrencies called stablecoins has been trying to replicate that kind of dependability in totally new ways. Some have used the equivalent of a digital vault to back up their promises. Others have tried solutions that are far more complex. The biggest of those, TerraUSD, also known as UST, and its sister token Luna have melted down in spectacular fashion, sending their prices to near zero and their market values plunging to a shadow of the combined $60 billion they once commanded. Its plunge has raised concerns that go beyond its narrow slice of the stablecoin world.

1. What’s a stablecoin?

A cryptocurrency designed to hold a steady value, in sharp contrast to the extreme price volatility seen for Bitcoin and other tokens. Stablecoins are meant to be useful, not to make their owners rich by soaring in value. They do that in two ways: by allowing crypto owners to conduct transactions without having to take volatility into account, and by offering them a safe haven for their holdings, protected from wild swings in the crypto market without having to convert their holdings into traditional money. The most popular stablecoin, Tether, can be exchanged for more than 4,000 other cryptocurrencies on centralized exchanges, according to crypto data firm Kaiko, making it one of crypto’s most traded tokens.

2. How do they hold their value?

They’re typically pegged to another currency: both Tether and UST were designed to be pegged to the US dollar. They maintain that peg in one of three ways. Tether and many other of the biggest cryptocurrencies maintain a reserve of cash or cash-equivalent assets whose value in theory matches the total value of the stablecoin in circulation. That is, when a user pays Tether $1 for a token, that money is supposed to be held in Tether’s bank accounts. Others, like MakerDAO’s DAI, maintain a reserve of cryptocurrencies rather than traditional money, but “overcollateralize”—hold reserves larger than the face value of their stablecoins to compensate for their volatility. TerraUSD, however, took the third route, operating as an algorithmic stablecoin.

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