It’s been a bad year for financial markets, especially for cryptocurrency assets. The cryptocurrency market cap has fallen from nearly $3 trillion last November to just $1.3 trillion. on May 18, bitcoin was trading at about $29,000, just 40% of what it was when it hit an all-time high last November. The price of another type of ethereum has plunged similarly. six months ago, Coinbase, a leading cryptocurrency industry company, had a market cap of $79 billion for the exchange’s stock. Now, the company has a market cap of just $14 billion and is “reevaluating the number of employees it needs.
The big sell-off in cryptocurrencies coincides with the timing of the Federal Reserve starting to raise interest rates. Tech stocks, high-yield bonds and other risky assets have also experienced big declines. But on a deeper level, the cryptocurrency crash is more interesting because of the weaknesses it reveals in the system’s downpipe.
The problem lies mainly in the stablecoin market. Stablecoins are a class of cryptocurrencies that are pegged to another currency (typically the U.S. dollar). The market crash put pressure on Tether, which was supposed to be pegged 1:1 to the U.S. dollar, and on May 12, the price of Tether fell to 95 cents. Since then, roughly $9.1 billion of Tethercoin has been converted back to cash. The technology and jargon of cryptocurrencies may be new, but this situation is not new to students of financial history because of its cool resemblance to the crisis of confidence that occurs before a bank run.
Each stable currency has mechanisms to keep it staring at the market. The simplest and safest method is to hold $1 of liquid assets (e.g., U.S. Treasury bills) in a bank account (or safe deposit box) for each stablecoin pass issued. The pass can be traded freely between buyers and sellers. When sellers want to sell a stablecoin for dollars, they either sell it on the open market or redeem it with the issuer of the stablecoin (who destroys the pass in question). usdc coin and tada coin use this model.
Others, such as Terra, are called “algorithmic stablecoins” and use an automated process to support market staking. However, they are most unique in the way they are backed by the value of the Terra coin, which is backed by Luna, a cryptocurrency issued by the same operator, Terraform Labs. The inherent concept is that holders of Terra coins are able to redeem them at any time for a newly minted Luna coin of $1. On May 5, Luna coins were trading at $85, which means that the holder of one Terra coin can redeem it for 0.0118 Luna coins. If, for some reason, Terra coins trade for less than $1, arbitrageurs will flock to buy Terra coins and redeem them as Luna coins and sell them at a profit.
The system was able to work as long as Luna coins had some market value. But on May 9, the price of Luna coin started to decline. The supply of Luna coins exploded, with the total number of passes reaching 350 million on May 10 and 6.5 billion on May 15. the price of Luna coins collapsed and the price of Terra coins went into free fall. Currently, the price of Terra coin is hovering around 10 cents and the price of Luna coin has gone to zero.
The founder of Terraform tried to save Terracoin. He has turned the blockchain off and on, “burned” the passes, and tried to split the blockchain. But so far, nothing has worked.
The implosion of Terra Coin has had a far-reaching and worrisome fallout: people are fleeing from Teda Coin. Those fleeing may be anxious about the lack of details backing the Terra Coin cryptocurrency. Teda had said it was backing its pass-through with “dollars,” but that claim was called a “lie” by the New York attorney general in 2021 and fined for it. Now the company says its passes are “100% backed by its own reserves. These reserves appear to be a combination of cash, Treasuries, and corporate bonds, but the company refuses to give details, claiming that its asset portfolio is a “secret sauce.
Just as depositors fled to safety during many bank runs in the past, holders are now selling Terra Coin and Teda Coin and flocking to what are considered higher quality pass-throughs. One of these is USDC coin, whose issuer holds only cash or U.S. Treasuries and is publicly known by the ongoing release of audit reports. Dai coin, another cryptocurrency-backed and algorithmically managed coin, has also found ways to maintain its staked price. The coin has good transparency, holds at least 1.5 times the required backing assets, and the supply of USDC coins and ethereum it relies on is independently controlled.
However, if TEDCOIN is not spared, then the survival of other stablecoins provides little comfort. If Terracoin is actually backed by illiquid or assets that have fallen this year, then the more holders who redeem their passes, the less of the pool is left for others. Compared to Terra Coin, the world’s largest and longest-running stablecoin, TEDA Coin’s collapse would be far more catastrophic. TEDA coin bridges not only cryptocurrencies to traditional currencies (such as dollars in bank accounts), but also to various cryptocurrency pairs (Crypto Pairs) that are traded on exchanges. For example, on the largest Binance exchange, the three largest and most liquid cryptocurrency pairs are: Bitcoin to TEDA; Ether to TEDA; and BUSD (Binance’s own stablecoin) to TEDA.
TEDA only offers redemptions to large users who withdraw $100,000 or more at once and have an active option to do so. However, redemptions have continued to grow over the past week, and on May 12, the failure of Teda to peg to the U.S. dollar reflected the strain on the system. In the week or so since then, Tadacoin holders have redeemed about $9 billion worth of pass-throughs, or 10% of the total. Smaller holders who wanted to pull out had to sell passes on the open market. The stablecoin has still not been able to fully resume its peg to the U.S. dollar. For a year, the price of TEDA coin has been at or above $1; since May 12, it has been slightly below $1 in all cases. The most important downpipe in the cryptocurrency system is still leaking.
Investors aren’t doing anything wrong: punishing instruments that are inherently flawed or poorly run by institutions. However, this has also reignited calls for further government involvement. The government should require the relevant institutions to provide more trustworthy information to help retail investors and institutions effectively prevent fraud. Crucially, stablecoin operators should be required to disclose information about their backing assets, including what assets are available, where they are held, and who controls them. In addition, for those large crypto exchanges that are already regulated, the government could publicize whether they have complied with disclosure requirements to help the market cloak itself in sand.