Industry experts explained how the UST situation has already affected the market and what to expect in the future

“Crypto winter is already here.” What will happen to stablecoins after the UST collapse

02.06.2022

269

7 min

In early May, the TerraUSD (UST) algorithmic stablecoin lost its peg to the dollar, and the exchange rate of the backing LUNA token also began to decline. The developers tried their best to restore the blockchain ecosystem, but they failed to do so. On May 13, the network suspended its activity, and a new blockchain, Terra 2.0, was launched on May 28. GetBlock Magazine turned to cryptocurrency experts to find out the reason behind Terra's collapse, as well as predictions about the future of stablecoins and other crypto-assets.

Events around the Terra project

After the stablecoin lost its peg to the dollar, developers attempted to rebuild the network with additional funding for the coin. Luna Foundation Guard (LFG), a non-profit organization, gave $1,5 billion in BTC and UST. The head of Terraform Labs, Do Kwon, proposed the idea of restoring the ecosystem by restarting the network with 1 billion tokens distributed among LUNA and UST holders, as well as a community pool. Kwon later put forward a proposal to conduct a hard fork of the network, but community members rejected the proposal in a vote, with 91% voting against it.

Also, in-house lawyers began leaving Terraform Labs. In addition, South Korean authorities accused Do Kwon and his company of corporate and income tax evasion. The Seoul Metropolitan Police Department asked local exchanges to block the non-profit LFG from withdrawing any corporate funds.

Even the G7 countries took notice of the blockchain collapse. Politicians called for an acceleration of “development and implementation of consistent and comprehensive regulation of cryptocurrencies.” On May 24, developers proposed launching a new network, Terra 2.0, which would not be linked in any way to the old blockchain. The community approved the proposal, and on May 28 it was launched.

GetBlock Magazine's editorial team prepared a full timeline of the Terra ecosystem collapse, as well as an in-depth look at all the events surrounding the launch of the Terra 2.0 network and the release of the new LUNA tokens.

Reasons for the collapse of Terra

Experts agree that there are several factors that triggered these events, and they were of a different nature. Nikita Zuborev, head of PR and marketing at BestChange.ru, believes that one of the main problems was the very concept of the collateralization of the asset. He explained that the stability of UST depended only on the stability of LUNA. The expert called the one-time sale of UST for $300 million a trigger that started this chain of events.

“Such large amounts can cause a squeeze in almost any asset pair, even on large centralized exchanges with enormous liquidity, not to mention creating terrible technical distortions in the moment for two interrelated assets,” Zuborev said.

According to Dmitry Noskov, the expert at the StormGain crypto exchange, another factor that played an important role in the collapse of the ecosystem was Terra's secondary project - the decentralized Anchor protocol (ANC). He explained:

“UST lost its peg to the dollar as there was a sharp outflow of assets from the Anchor protocol. As a result of this decline, the yield on deposits fell to 17.87%. Several factors contributed to this at once: both the general decline of the crypto market and the lack of regulation.”

Nikita Zuborev also mentioned “inflating” the issuance of stablecoin in an attempt to restore the peg. The expert believes that such a decision only worsened the situation, as the increased number of tokens did not increase capitalization, and the total value of the capital was still falling.

Among other factors, according to Zuborev, the decadence of UST and LUNA holders was negatively affected by the inept sale of the Luna Foundation Guard stabilization fund, which led to an even greater outflow of assets.

Can a similar situation happen again with other stablecoins?

The Terra collapse was the first precedent for the destruction of an entire stablecoin ecosystem. Experts agree that because of this situation, confidence in the stablecoin market decreased significantly, and from now on, investors will carefully study the organization of projects.

“What happened with UST moved the theoretical risk to the category of precedents that happened, but this event did not bring real existential risks,” Zuborev noted.

It's worth understanding that all stablecoins have a different organizational structure and therefore a different security format, he said. The expert explained that most of the popular stablecoins are centralized (for example, USDT, and USDC) and collateralized by real currency in bank accounts or US government bonds.

At the same time, the collapse of Terra had some preventive effect on other stablecoin issuers, Noskov believes. The developers of similar projects have obviously drawn conclusions from the situation and began to reconsider the mechanisms of protection and security of their assets, the expert said.

A new “crypto winter” is coming

Experts disagreed on the new stagnation in the cryptocurrency market, (a similar one previously occurred in 2018-2019). Zuborev believes that “crypto winter” has already begun - during the last half of the year there is a decrease in the capitalization of the digital currency market, and the prices of the top assets fell by 40-60% of their all-time highs (ATH).

“In other words, there is now no prospect for a noticeable growth in cryptocurrency prices in the medium-term planning period, this can be technically considered a “crypto winter.” According to various estimates, it will last from half a year to a year and a half, if we consider historical patterns,” - the BestChange.ru expert explains.

Noskov noted that the cryptocurrency market is now highly correlated with the traditional asset markets, and it is affected by the US Federal Reserve System's (Fed) tighter monetary policy measures.

“Because of record-high inflation, the Fed is increasing the rate, and that's putting pressure on the stock market, and therefore on the cryptocurrency market as well,” Noskov explained.

However, Vasily Kudrin, co-founder of Goldman Digital and investment director of the international group Lybrion, believes that there are significant differences from the previous “crypto winter” - now there is a fairly strong, but still temporary “cooling-off period.” Kudrin noted that the cryptosphere is in its second “spring cycle” of industry development, which began back in mid-2020. According to him, the cycle itself will last another 5-7 years until the real “freeze” occurs.

The Future of the Stablecoin Market

After the collapse of Terra, stablecoins suffered a serious reputational blow, and the market will take a long time to regain investor confidence. However, there are some positive aspects: most stablecoin issuers have begun to modernize their ecosystems, and regulators in various countries have accelerated the development of bills to regulate digital assets.

“The sphere of stablecoins will expand and improve, including with the digitalization of fiat, namely the development and introduction of digital currencies by central banks. One of the important incentives may also become more accelerated development of the asset-backed token market, and this, in turn, will greatly increase the real sector's perceived interest in the crypto industry,” Kudrin explained.

Nikita Zuborev emphasized that a crisis of confidence will arise in relation to algorithmic stablecoins. As for centralized stablecoins, he believes, nothing will change, traders and investors will still need these assets to fix their positions and stabilize collateral for margin transactions.

Globally, the market will only benefit from what has happened, the BestChange expert believes. DeFi-segment developers will take into account new risks when designing future smart contracts, thereby making decentralized finance more secure from possible manipulation.

Author:

Vasiliy Smirnov Vasiliy Smirnov

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