The not-so-stable stablecoin economy
In May 2022, the global financial market witnessed another unprecedented event that sent ripples through investment markets. The month saw the global cryptocurrency market crash and a modest chunk of market participants rushed to safeguard their investment by selling off at a loss. A few crypto market participants faced a far worse fate as they were left with no option but to declare bankruptcy.
While cryptocurrencies and digital coins seemed like a promising investment during Covid-19 lockdowns and people jumped the hype train to pour their savings into digital currencies, the same audience is slowly and gradually becoming averse to them. There is no doubt that cryptocurrencies emerged as a strong option to park savings during the pandemic and outshined almost every other investment avenue globally however, the rally seems to have lost steam as soon as the global economy reopened and alternates turned attractive.
On May 10, bitcoin, the cryptocurrency with the largest market capitalisation, dropped below $30,000 while the global cryptocurrency market lost around $800 billion in market value in the past month, according to CoinMarketCap. In a prolonged selloff, the apex cryptocurrency lost one-third of its value in just eight days earlier during the month.
Being the apex coin in the crypto market, a sell off in Bitcoin places all other currencies on a southbound journey and this time was no different.
To gauge the reasons behind the recent bear run and to gain an insight into the current state of cryptocurrency market, The Express Tribune reached out to prominent experts in the field.
A stable alternative?
Speaking to The Express Tribune, Belgian cryptocurrency analyst John Klien said that before delving into the cryptocurrency market, it was vital to understand stablecoins.
“Stablecoins, as the name implies, are a subcategory of digital currencies that are either free from volatility or face negligible fluctuations in their value,” he said. “Such coins operate through multiple methods and the most prominent one is to peg them to a value of an asset that exists in the real world to end volatility in their prices.”
Therefore, stablecoin founders are free to link them to dollar, gold, nickel, coal, oil, silver or any other asset in a bid to stabilise its price.
At present, a stablecoin can only be linked to one single asset however, this might change later on when the concept of cryptocurrencies matures. A stablecoin can also be linked to a cryptocurrency or other stablecoins hence the underlying asset that backs such coins does not need to be physically available. The asset can be virtual as well. Linking stablecoins to currencies make them an alternate to using fiat money and enable the public to convert their currency notes to stablecoins so that people don’t have to carry their wallets. Being pegged to a dollar, one stablecoin is worth $1 hence this offers people an incentive to store their money digitally and ditch wallets. It also ends the need to carry wallets.
Stablecoins are supposed to exchange at $1 per coin to act as a true alternate to dollar. This means that one stablecoin could be exchanged for $1. In case the price of a stable coin falls below $1, it can still be traded for $1 which makes it a hedge. On the other hand, if the price of a stablecoin rises over $1, it would still be exchange for one dollar.
Similarly, they can act as parallel currency to euro, pound or even Pakistani rupee if these currencies are chosen as underlying assets for them. Because stablecoins have an underlying asset, the founders have to build up reserves to regulate them. A dollar backed stablecoin would have dollar based reserves and euro based one would have euro based reserves.
Klien admitted that there was a global debate to separate stable coins from cryptocurrencies because they functioned differently while being linked to an asset. Other cryptocurrencies are not pegged to any asset hence their prices are prone to register wild swings.
Collapse of terra and luna
Talking about the factor driving the sell-off in the cryptocurrency market, he added that stablecoins collapsed this time around but there were two particular coins ie Terra and Luna that drove the market collapse.
Terra is an exceptional stablecoin because it is linked to another stablecoin called Luna. Luna is backed by Luna Foundation Guard (LFG) that uses bitcoin-based reserves to keep terra’s price stable. Purchase of one Terra means that one Luna is burned hence one terra is equal to one luna. In case luna’s supply ends owing to a massive sell-off, LFG is expected to sell bitcoins to float more lunas in the crypto market.
“According to reports, an anonymous person sold $350 million worth of terra (or 350 million terracoins) in one transaction,” he stressed. “This sparked the need to create 350 million lunas in a small amount of time to keep maintain luna-terra parity at 1:1.”
However, this mounted pressure on LFG because it is not possible to create such a huge amount in a small window of time. It can take days and even months to create 350 million lunas, he said. Initially, it declined terra to 0.95 luna which distorted the parity. This further, people to offload terra further to safeguard their holdings and receive one luna per tera sold. As a result, the amount of luna in the market became insufficient to support terra.
In response, the LFG began selling its bitcoin reserve in huge amounts to create lunas and this sent bitcoin’s price spiraling downward. As a result, all cryptocurrencies fell and the value of terra and luna plunged close to $0.
“Basically, terra and luna collapsed and this caused a crash in the cryptocurrency market,” he said. “There is also rumour that the $350 million transaction was aimed at crashing terra and making short term gains.”
He added that the losses borne by the crypto market are far higher than 2008’s global financial crisis. He admitted that low awareness of cryptocurrencies saved a lot of markets at this terrible time.
El Salvador was celebrated as the first country to adopt cryptocurrency as the mode of payment but owing to the latest crash, it is on the verge of defaulting on its sovereign debt, he stated.
In response to this fiasco, Binance, the largest cryptocurrency exchange in the world halted the trading of the terra.
“The Terra network is experiencing slowness and congestion, which is intermittently causing a high volume of pending terra network withdrawal transactions on Binance,” it said. “We are continuously monitoring the network status and working to provide Binance users the best possible experience.”
It said that the company was also working to increase the number of wallets to speed up the processing of withdrawals and support more withdrawal requests. However, there may be periods where withdrawals on the terra network are temporarily suspended due to the network congestion.
The firm promised to reopen deposits and withdrawals for the terra network once the network is stable.
In a series of tweets, CEO Changpeng Zhao said these past weeks have proven to be a watershed moment for the crypto industry.
“We have witnessed the rapid decline of a major project, which sent ripples across the industry, but also a new found resiliency in the market that did not exist during the last market downswing,” he said. “The last few days, we tried hard to support the Terra community. I am simply pointing out the potential issues from my understanding. Minting, forking do not create value. Buying back, burning does, but requires funds. Funds that the project team may not have.”
He called for more transparency from the Terra team including specific on-chain transactions of all the funds.
He added that relying on third party analysis was not sufficient or accurate.
Impact of dip
Immediately after the crash, tether, world’s largest stable coin that is pegged to a dollar, fell to as low as $0.95 per coin. This caused its holders to offload the currency however, Tether’s Chief Technology Officer Paolo Ardoino stated that the holders had nothing no fear since the stablecoin was backed by dollar. He clarified that asset back stablecoins were different than algorithmic stable coins such as terra. Following his announcement, tether’s regained its market peg of $1.
Major crypto exchanges and platforms around the world have also delisted terra and luna from their platforms. Indian investors lost big time in the dip hence a lot of exchanges in the country have removed these two coins from their platforms.
This also proves that stablecoins cannot replace fiat currencies because they are prone to volatility whole the currency is not, he said. “The current value of terra or luna is similar to that of a shitcoin. Such cryptocurrencies are valued near $0 and thats what the twin stablecoins amount to right now.”
Giving example of a shitcoin, he said that it was valued at $0.00014 which was affordable by a majority of global population but not profitable and would likely fall to $0 in a matter of a few months or years.
The recent dip has pushed a lot of shitcoins towards $0 as well and micro crypto investors are suffereing as well, he said.
Moreover, it also spooked first time crypto investors since they never thought that a stablecoin could crash and wipe off all their investment.
“This came as a surprise for the market because until now, stablecoins were considered safe havens. The crash changes the way people and the market will look at stablecoins from now on,” said Klien. “Cryptocurrency market is still at nascent stage therefore it is evolving. Right now, there are a lot of theories but not everyone is correct and with time, we are realising how right and wrong we are with regard to cryptocurrencies.”
He agreed that overall cryptocurrency market participation will take a massive hit going forward because inexperienced in investors were already pulling out.
“In crypto market, there seems to be no such thing as safehaven. Digital coins are highly volatile and the latest dip only reinforces this idea,” he said highlighting that cryptocurrencies were high risk investment hence “not everyone can profit from it.”
He further believed that bitcoin reached its maturity and it would largely remain between $30,000-60,000 level going forward. According to him, early bitcoin investors had made massive gains but such a thing was impossible now due to two reasons. First is purchasing power and second is risk. Only a small chunk of society can buy bitcoin even at recent low level of around $30,000 per coin hence majority is excluded from pouring money in it. Secondly, there is inherent fear that the same investment in real estate or automobile sector might reap more gains.
The drop in stablecoin has triggered fear of bankruptcies because it usually appeals to low risk investors who have limited liquidity and many poured all savings into it as it was promoted as safe haven digital currency.
Moreover, it is a lesson for central bank digital currencies. Since the central bank digital currencies will be backed by some kind of asset, they will function similar to stablecoins therefore this acts as a case study for them to prepare strategies for massive selloffs and buying.
Rahul Singh from India invested $12,500 into terra and lost all of it in the dip.
“I got lucky while investing in cryptocurrencies during early years and made windfall gains,” he said. “Now, I poured all of them into stablecoins and the amount has disappeared. I was making steady gains but then a sea of red took placed and before I could digest it, all my savings had eroded.”
He stated that if he had invested it in real estate, he would have made some return even during the worst economic conditions.
“I believed I knew cryptocurrencies inside out however such was not the case. Safe havens simply do not exist in cryptoverse and I learned it the hard way. Safe havens such as gold are the best kind of investment.”
According to him, terra would not be an isolated case. There are tons of other stablecoins operating on the same model and their founders should learn a lesson from this while investors should remain wary, he said.
Singh has now exited cryptocurrency market once and for all and advises its participants to either park not more than 50% of their savings into it or gain full knowledge of the mechanism.
Although the impact of the bloodbath in the cryptocurrency market had a negligible impact on Pakistan because of uncertain status of digital coins in the country, still the people directly hit by the incident are reporting massive losses.
Jamal Shaikh stated that he was nearly bankrupt from the recent fall in cryptocurrencies, driven by stablecoins.He recalled that he entered the cryptocurrency market in 2017 when he parked his savings into multiple prominent coins.
“I forgot about that till 2020 but during Covid-19, I lost my jobs and was pooling in all the money when I remembered I had invested in digital coins,” he said. “When I revisited the investment, I realised that my money had multiplied by a manifold and it helped me get back at my feet. Not only that, I was able to buy a brand new car when people were unable to afford daily necessities and since that day, I have been investing in cryptocurrencies and usually making profits”
Shaikh also got a hit in the recent bloodbath at the crypto market and his investment halved. For now, he has withdrawn all his money and he is looking for the right time to re-enter the market.
He stressed that the State Bank of Pakistan’s inaction over legalising the cryptocurrency saved a lot of Pakistanis from losses during the ongoing economic crisis.
Take the case of India. A lot of investors are drained of their money and they have nowhere to go, he said.
He forecasted people in other regional countries to have suffered similar fates.
“Basically, the third world economies that permitted the use of cryptocurrencies are regretting it and terming their decision premature,” he said. “Cryptocurrencies are a complex phenomenon and there are just a handful of experts in the world.”
A possible remedy
Shaikh urged upon all economies that legalised the trading of cryptocurrencies to create a crypto currency authority which would keep an eye on incidents such as the terra-luna fiasco and issue guidelines to the public in a bid to safeguard it from mammoth losses.
In El Salvador, the country as a whole lost a massive amount of dollars because its government invests in cryptocurrencies. He detailed that the nation had long struggled to have an official tender and few years back, it adopted dollar as its official currency.
“That created more problems than it solved hence the country was looking for alternatives to for a long time,” he said. “When it saw the success of cryptocurrencies, it jumped the bandwagon and it was arguably a wrong decision.”
According to him, cryptocurrencies were a recent phenomenon and country should wait to see its drawbacks and loopholes before deciding to adopt it as digital currency. He pointed out that event stock markets crashed several times and then nations acted to lay down or revise regulations for it to never happen again therefore there was a need to adopt a wait and watch stance with cryptocurrencies.
He noted that Wall Street Crash of 1929 and 1987 sell off laid down the foundations of the modern stock market trading. Similarly, he exemplified that Asian financial crisis in 1997 and global financial crisis in 2008 helped bolster the financial system.
“Looking at these examples, it is a mistake to adopt cryptocurrencies which a just a decade old,” he said and recommended countries to wait atleast 10 more years and see digital coins fail and crash several more times to be ready to adopt it.
Hanif Khan, who deals in non-fungible tokens (NFTs) in Pakistan, said that the latest crash had dented his business. He elaborated that non-fungible tokens were primarily exchanged by transferring cryptocurrencies from one account to the other.
“To make it easy, the underlying currency for purchase and sale of non-fungible tokens is cryptocurrency,” he said. “Since cryptocurrencies are volatile, people began paying for non-fungible tokens through stablecoins.”
Citing the reason behind this, he noted that digital currencies like bitcoins can rise or fall over $20,000 per day hence the price quoted in bitcoin today would surely be different tomorrow. Khan underlined that it was difficult to state prices in volatile cryptocurrencies because by the time the customer made the decision to purchase, the price of the cryptocurrency would have swung upward or downward.
As a solution to this, NFT business switched over to stablecoins because they are usually valued at $1 per coin so it became easy to quote prices with nearly no fluctuations. This recent fall made Khan’s business go haywire. Prices on his NFT platform are quoted in tether which felt the ripple effect of terra and luna crash.
“This whole event demands either a new category of cryptocurrencies to help NFT businesses or an entirely new payment method that is different from volatile cryptocurrencies,” he said. “All in all, the faith in stablecoins is lost now and slowly and gradually, people will drift away from them. Clearly they failed to perform their basic function of facing negligible to no fluctuations.”
As a solution to this, Khan suggested imposing limits to stable coins under which they cannot fall or rise to a level more than a particular percentage. He recalled that Pakistan Stock Exchange had that system where the KSE-100 index halts trading for some time once KSE-30 jumps or dives 5%.
“This kind of a solution is required to restore faith in stablecoins,” he said.
Currency of the future
Nevertheless, the scope of cryptocurrencies does not end with this incident. There are diverse uses of digital coins which will support whole crypto ecosystem. One of its questionable uses is that it is a medium of exchange on deep and dark web. Other than this, the tech giants of the world are planning to set up a metaverse which is a virtual world and it is expected to overtake social media by a storm.
Cryptocurrencies have a drastic role to play in the metaverse and it would be build around the idea of cryptocurrencies. While the popularity of cryptocurrencies surely takes a hit after the collapse of stable coins but being at a nascent stage, digital currencies have a long way to go and drastic scope to become the currency of the future.