London/New York — The meltdown in TerraUSD, one of the world’s largest stablecoins, rippled through cryptocurrency markets on Thursday, pushing another major stablecoin Tether below its dollar peg and sending bitcoin to 16-month lows.
Cryptocurrencies have been swept up in a sell-off in risk assets, which has picked up steam this week as data showed US inflation running hot, deepening investor fears about the economic impact of aggressive central bank tightening.
The sell-off has taken the combined market value of all cryptocurrencies to $1.2-trillion, less than half of where it was last November, based on data from CoinMarketCap.
Bitcoin, the largest cryptocurrency by market cap, hit a low of $25,401.05 on Thursday, its lowest level since December 28 2020 It was last down 2.1% at $28,400.
In the past eight sessions, it has lost more than a quarter of its value, or about $10,700, and is down 37% so far in 2022, trading far below the peak of $69,000 it hit in November 2021.
Bitcoin’s correlation with the Nasdaq composite has been on the rise recently and is now up near its all time highest level, based on Refinitiv data. The Nasdaq composite has tumbled about 8% so far in May.
Ether, the world’s second-largest cryptocurrency, fell to its lowest since June 2021, sinking as low as $1,700.
Unlike previous financial market sell-offs, when cryptocurrencies have been largely untouched, the latest selling pressure in digital currencies has undermined the broader argument that they are dependable stores of value amid market volatility.
Stablecoin TerraUSD has been hit by the turmoil and broke its peg to the US dollar, which led to it falling as low as 31c on Wednesday. On Thursday it was trading around 38c.
“Unfortunately, the fallout from this situation goes beyond the material losses sustained by investors,” said Anto Paroian, COO at crypto asset hedge fund ARK36.
“The de-pegging will likely result in a substantial regulatory risk — if not for the whole crypto space, then certainly for the stablecoins market.”
Stablecoins are digital tokens pegged to the value of traditional assets, such as the dollar. But TerraUSD is an algorithmic, or “decentralised”, stablecoin, and was supposed to maintain its dollar peg via a complex mechanism that involved swapping it with another free-floating token.
On Thursday, Terra developers halted the network’s blockchain to prevent attacks following the collapse of its algorithmic stablecoin and the related Luna token. The Terra blockchain, however, has since restarted.
The non-profit Luna Foundation is an affiliate of Terraform Labs, the company behind the TerraUSD.
Even stablecoins backed by traditional assets were showing signs of stress on Thursday.
Tether slipped below its 1:1 dollar peg, hitting a low of 95c on Thursday, based on CoinMarketCap data.
“The lack of transparency provided by Tether on the quality of commercial paper they hold to back the peg made it the obvious next target,” said Usher.
“However, Tether is a very different animal to Terra, with a more proven ecosystem and I have far more confidence that when volatility subsides it can regain its peg and stability,” he said.
Paolo Ardoino, Tether’s chief technology officer, said in a Twitter Spaces chat that the stablecoin had reduced its exposure to commercial paper over the past six months and now holds the majority of its reserves in US Treasuries.
Tether is the largest stablecoin by market cap, and, along with USD Coin and Binance USD, they account for almost 87% of the total $169.5bn stablecoin market, according to CoinMarketCap.
The large number of centralised cryptocurrency exchanges and decentralised venues, each with their own liquidity profile and credit risk, was adding to price distortions across the market, Denis Vinokourov, head of research at Corinthian Digital Asset Management, said.
“The spillover effects into other stablecoins is in part driven by the fragmented nature of the market,” Vinokourov said. “This credit risk, especially during the times of tight liquidity conditions and mass deleveraging leads to further price distortions.”
Market players are still assessing the impact of TerraUSD’s troubles on investors.
In its biannual Financial Stability Report on Tuesday, the US Federal Reserve warned that stablecoins are vulnerable to investor runs because they are backed by assets that can lose value or become illiquid in times of market stress.