“There’s a general downturn in the financial system right now, and that means everything is stress-tested, so what can break will break,” said Michael Gronager, co-founder of the world’s largest financial firm. world crypto data analysis, Chainalysis. The Australian Financial Review from New York.
“All of these projects start on a sunny day when everything works, but when the storm comes, they can blow up, and we find out if they’ve invested enough in the problem of ‘what happens when all the money goes rush?'”
burn and knock
Prior to Tuesday, terraUSD, or UST, was an algorithmic stablecoin that had attracted more than $18 billion in investment and was the backbone technology for hundreds of small start-ups, including Australian company Tiiik.
But unlike other stablecoins which are backed by real US dollar assets, UST used financial engineering to keep its peg at US$1.
However, tether, a stablecoin allegedly backed by U.S. dollars and other U.S. assets, also decoupled from its U.S. dollar peg on Thursday night, falling 3% to US96¢.
The idea was that if the price of UST fell below US$1, traders could “burn” the coin – or permanently remove it from circulation – in exchange for $1 worth of new units of another crypto. -currency called luna.
This reduces the supply of terraUSD and increases its price. Conversely, traders can “burn” luna if terraUSD climbs above 1 USD.
In exchange for all these burnings and strikes, traders were rewarded with an 18% “interest rate” paid by the organization behind UST called The Luna Foundation Guard, founded by Do Kwon.
“You basically use these very high returns to get enough people to your stablecoin, do the peg holding work and then hope it hits critical mass where the peg stays stable and you can reduce that high rate of return which is costing you a fortune,” said Josh Reyes, co-founder of Minke, a crypto interface tool.
“The idea is to automate and decentralize the function of a central bank trying to keep its own currency stable against the US dollar.”
Like a central bank keeping a stockpile of foreign exchange reserves, the team behind the Luna Foundation Guard had built a $3.5 billion bitcoin treasury to deploy in case traders suddenly stopped supporting the peg and caused a stampede. on the assets, which happened. this week.
Monday, peg dropped to 69¢ US.
This spooked traders, who used to get US$1 for each trade, and the selling pressure increased.
In response, the Luna Foundation Guard sprang into action and started using their bitcoin cash to buy UST and support its price peg, but they hadn’t counted on a sharp deterioration in bitcoin’s price at the same time, diluting its purchasing power.
“The Luna Foundation guys just didn’t have enough bitcoin to support their own peg, which is why it just craterd this week,” said Jesse Smythe, portfolio manager of Balmoral Digital, a manager of digital assets based in Sydney.
According to the analysis of the blockchain seen by the Financial analysisaround $1 billion worth of USTs were sold over the weekend, enough to flood the market and dislocate the UST from its $1 peg.
“Stress in the System”
Australian-born cryptocurrency investor Richard Galvin was among them, liquidating most of his holdings in luna, the digital token linked to the terra network, after detecting “significant stress in the system”.
He was unable to fully sell due to a portion of his luna holdings being locked and earmarked for “staking” – loaned out to help validate the underlying blockchain and earn rewards.
Mr. Galvin started buying the asset in mid-2020 when it was trading at around 23¢ a coin. He has since widened the allocation, estimating that it has returned about $35 million to unitholders of his venture and wholesale funds, about 40 times the original investment.
“That’s not to say our funds aren’t materially affected by Luna’s collapse,” said Mr. Galvin, managing director of Digital Asset Capital Management and a former JPMorgan banker.
“We are reminded that when you invest in highly disruptive technology, there is a lot of uncertainty and volatility. We invest in highly experimental and untested new assets and ideas that are more reflexive than anything most investors are used to.
But Mr. Galvin was one of the lucky ones. On Thursday, traders had fled the stablecoin which was hailed as a technical breakthrough, sending it as low as US30¢, although it managed to recover to around US50¢ on Thursday evening.
However, Fred Schebesta, founder of financial comparison site Finder, said there was still hope for a rebound. The Young Rich Lister previously called Terra a “beast to be reckoned with” and Luna among his top coin picks, but claimed he sold his holdings between those comments and this week’s crash, and that he was unable to remember when.
“Terra was doing really, really well and unfortunately the mechanism didn’t work,” Schebesta told the Financial analysis. “They tried to get around that and they tried to fix that by buying bitcoin but…unfortunately it didn’t work. It’s a really sad thing for crypto and it’s also a really sad thing for decentralization.
Kanish Chugh, head of distribution at ETF Securities, said the terra collapse and broader crypto market selloff contributed to “relatively low” trading volumes seen by his company’s listed bitcoin and ethererum ETFs. on the Cboe Australia stock exchange on Thursday.
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