Why TerraUSD Is Partly to Blame as Bitcoin Prices Plunge

But there is likely at least one more force that has pushed Bitcoin to its lowest levels since July 2021, to below $33,000 on Monday from around $36,000 on Friday. Look no further than TerraUSD, a so-called stablecoin that is intended to be pegged to the U.S. dollar, and


Luna,

another cryptocurrency that helps Terra maintain its link.

While the largest stablecoins—


Tether

and


USD Coin

—are backed by cash or cash equivalents to help these tokens maintain their 1:1 relationship with the U.S. dollar, Terra is different. As an “algorithmic” stablecoin, TerraUSD primarily maintains its peg to the dollar through a market mechanism involving another cryptocurrency, Luna. 

The Terra protocol allows traders to take advantage of an arbitrage opportunity when TerraUSD weakens below the value of a dollar. They can “burn” one TerraUSD for $1 worth of Luna, making a profit and taking a TerraUSD out of circulation when the stablecoin’s price slips below the dollar, or do the reverse when the TerraUSD strengthens.

The popularity of TerraUSD has exploded over the past year, helping the price of Luna rise from around $35 in October to a high of $116 last month.

But it all hit a hiccup over the weekend. Sudden selling pressure caused TerraUSD to depeg from the dollar, dropping as low as 98.6 cents on Saturday, and the price of Luna crashed. While the market stabilized, it then happened again on Monday, when TerraUSD dropped as low as 97.8 cents and Luna extended declines to more than 30% since Friday.

The initial depegging looks to have been prompted by a series of withdrawals of Terra from the Anchor Protocol, which is a decentralized-finance lending market that allows depositors of TerraUSD to earn high yields. Much of the 18.7 billion TerraUSD in circulation is locked into Anchor, which saw its deposits of the stablecoin fall from $14 billion on Friday to less than $11 billion by Monday.

Stablecoins are supposed to be boring, without the volatility of Bitcoin. They act as a monetary bridge between the worlds of fiat currencies and cryptos, and are the foundations of the $2 trillion digital-asset market, playing a critical role in the crypto financial system. 

A wobble in Luna and TerraUSD, the ninth and 10th largest digital assets, is no small thing.

“Huge UST withdrawals from Anchor Protocol on Saturday demonstrated the fragility of algorithmic stablecoin where its price, which is supposed to be pegged to the U.S. dollar, was depegged,” said Yuya Hasegawa, an analyst at the crypto exchange Bitbank, also noting the crash in Luna. “The selloff of the altcoin affected the price of Bitcoin.”

Marcus Sotiriou, an analyst at the digital asset broker GlobalBlock, echoed that sentiment. “There is fear in the crypto space too with TerraUSD,” he said.

This isn’t the first time TerraUSD has depegged from the dollar, but this is likely the most high-profile incident. The founder of Terra, Do Kwon, announced in March that $10 billion worth of Bitcoin would be purchased as reserves to protect Terra’s peg.

The Luna Foundation Guard, which was set up to protect Terra and counts Kwon among its leaders, said in a statement that it was mobilizing to ensure market stability. The foundation said it would loan $750 million worth of Bitcoin to market makers, or trading firms, that would help to protect the TerraUSD peg and liquidity. The group also said that it would loan 750 million TerraUSD for the purposes of accumulating more Bitcoin as market conditions normalize.

As Terra and other algorithmic stablecoins have exploded in popularity, experts have raised concerns about how the market mechanisms underpinning Terra and its peers could be a risk for the wider crypto space. 

In a series of tweets and retweets over the weekend, Kwon, Terra’s founder, implied support for the theory that the stablecoin’s depegging was the result of a coordinated attack. That narrative is circulating widely within the crypto community.

TerraUSD’s move away from the dollar is only by a few cents—it’s by no means developing into a “death spiral” that could cause wider destruction—but it has still rattled the crypto market, because it’s not supposed to happen.

“[TerraUSD] has managed to avoid a major break away from its [U.S. dollar] peg during the weekend’s volatility,” said Stephane Ouellette, CEO of crypto derivatives firm


FRNT Financial

(ticker: FRNT.Canada.). “The stablecoin, however, is likely to face further tests as the crypto market continues to face pressure in the coming days.”

Write to Jack Denton at jack.denton@dowjones.com


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