It’s just one token, but it’s a big one.
So the big news last week is the collapse of the cryptocurrency “Luna”, and the associated stablecoin ‘Terra’.
Crypto coins explode and crash and burn everyday so there’s nothing particularly unique about that.
What’s unique is that the stablecoin had one job and it just didn’t do it.
If you haven’t invested much in crypto, stablecoins are like the chips you use at a casino, as one regulator put it. You turn your ordinary Aussie dollars into stablecoins, and then use those stablecoins to trade in and out of crypto currencies.
It’s allows you to execute trades without the hassle of converting your money in and out of fiat.
On some estimates, about 70% of Bitcoin transactions are done through Tether – the largest of the stablecoins out there.
And stablecoins, like it says on the box, aren’t meant to change. One of Tether’s UST’s should always be equal to one USD.
That’s exactly the point.
But last week, the fourth largest stablecoin, Terra, collapsed. It lost its peg to the dollar and is now functionally worthless.
Not only that, it took down its sister currency Luna with it.
In April Luna was worth US$116. Today its worth nothing.
The reason for that is a little beyond what I have time for, but basically, Terra maintained its peg to the dollar “algorithmically” through buying and selling of Luna.
In hindsight, nobody thought this was a good idea, because as the peg is tested to the downside, more and more Luna have to be printed, which puts downward pressure on Luna, with erodes confidence in the peg, and you have what they call a ‘death spiral’.
As Luna tried to fend off collapse, it just printed more and more and more. The number of coins in supply went from 345 million to 6.5 trillion in a matter of days.
That’s money printing on steroids.
And with the collapse of the world’s fourth largest stablecoin, the price of Bitcoin got hammered, and many people are now wondering about the fate of crypto itself.
I don’t think this is the end of cypto – it’s survived much worse. But it is significant.
First, because it puts pressures on the other pegs. Tether, the worlds largest with almost half of all stablecoin value, is pretty controversial.
Its supposedly back one for one with real US dollars – or dollar like instruments like Treasury bonds, but no one really knows. Many doubt that the money actually exists.
And so that raise the prospects on more ‘attacks’ on the pegs.
I don’t know if you’re old enough to remember when George Soros broke the bank of England and destroyed the Pound’s peg to the German Mark.
But basically pegs create one way bets. If you short the pound (bet that it falls) the worst that can happen is that the peg holds, the pound doesn’t fall, but it doesn’t go up either.
But if it does go down, you can make a squillion, which is what George Soros did. (The world’s first billion dollar trade apparently.)
So if things start to look shaky, there will be a lot of people lining up to test those pegs.
Second, if stablecoins go down, it will do serious damage to the crypto space.
Their combined value (at around $180bn at the end of February) is less than 3 per cent of the crypto market.
But on daily trading volume, Tether’s trading volume is more than Bitcoin and Ethereum combined.
Stablecoins provide liquidity, and without liquidity, the whole show risks falling over.
Finally, it’s not clear how far this story is going to bleed out into the financial system.
The total crypto market cap has fallen from around $3trn to $1trn from its peak last year.
Of that lost $2trn, about $1trn is retail – mum and dad investors and crypto-chads.
But another $1trn is institutional. We’ve been hearing a lot about how the institutional players were getting involved. Institutional players accounted for around two thirds of trading volume on Coinbase last year, about from about nothing a few years ago.
So Wall St has lost a trillion.
That’s not a huge amount in the scheme of the global economy, but it really depends on how leveraged it is.
That much, highly leveraged, is what gave us the Global Financial crisis.
So that’s why the collapse of this particular crypto token is potentially big news.
Crypto will bounce back.
But this is a Black Swan that will keep circling the economic outlook this year.
JG.