First Mover Asia: Bitcoin at 16-Month Low as UST Collapse Shows Risks of 'Algo' Stablecoins

A number of algorithm-based stablecoins have already failed; bitcoin and other cryptos see deep red.

May 11, 2022 at 11:38 p.m. UTC
Updated May 13, 2022 at 6:24 p.m. UTC

Shaurya is an analyst/editor for CoinDesk's markets team in Asia.

Damanick is a crypto market analyst at CoinDesk where he writes the daily Market Wrap and provides technical analysis. He is a Chartered Market Technician designation holder and member of the CMT Association. Damanick is also an equity/fixed income portfolio manager and does not invest in digital assets.

James Rubin is CoinDesk's U.S. news editor based on the West Coast.

Good morning. Here’s what’s happening:

Prices: Bitcoin hits its lowest point since December 2020 amid UST's implosion.

Insights: Algo stablecoins may not be such a great idea.

Technician's take: BTC is deeply oversold, but upside appears limited.

Catch the latest episodes of CoinDesk TV for insightful interviews with crypto industry leaders and analysis. And sign up for First Mover, our daily newsletter putting the latest moves in crypto markets in context.

Prices

Bitcoin (BTC): $28,550 -8.1%

Ether (ETH): $2,050 -12.8%

Biggest Gainers

There are no gainers in CoinDesk 20 today.

Biggest Losers

Asset Ticker Returns DACS Sector
Internet Computer ICP −30.9% Computing
Polygon MATIC −28.0% Smart Contract Platform
Solana SOL −27.5% Smart Contract Platform

Cryptos tumble amid LUNA implosion

Ouch.

What else was there to say about Wednesday trading in crypto markets?

Bitcoin fell to $27,700 at one point to a 16-month low before regaining some ground, but it was still part of a mass sell-off of digital assets triggered by the terraUSD (UST) stablecoin implosion against its 1:1 dollar peg.

"It is a very nervous time in crypto markets following the collapse of the controversial stablecoin UST and as the majority of institutional crypto investors that invested last year are now losing money," Oanda Americas Senior Market Analyst Edward Moya wrote.

Terra blockchain LUNA token token, which was created as a buffer against the volatility of UST stablecoin plunged 96% at one point after the Luna Foundation Guard, the non-profit established to support the Terra network, moved its reserves to bitcoin exchanges to defend the dollar peg. UST dropped as low as 23 cents before recovering to 77 cents later in the day. Stable it wasn't.

Bitcoin, the largest cryptocurrency by market capitalization, was recently trading at $28,500, down about 7%, although it fared better than most other major cryptos, underscoring its status as a less risky option during tumultuous times for the wider digital assets market. Ether, the second-largest crypto by market cap, was also off, declining approximately 11% over the same period, to roughly $2,050.

The charts were even darker red and included AVAX, SOL and SAND, which recently dropped 36%, 33% and 31%, respectively. Popular meme coins SHIB and DOGE tumbled about 29% and 26%, respectively.

Equity markets shared in the misery as investors digested the latest U.S. news on inflation, which ticked slightly lower in April, but remained at four-decade highs. The prices for groceries and other consumer goods, airline travel and service industries spiked amid rising energy costs and supply chain slowdowns exacerbated by Russia's unprovoked attack on Ukraine.

The tech-focused Nasdaq sank over 3% and the S&P 500 and Dow Jones Industrial Average each dropped over 1%. Meanwhile, gold, the traditional safe haven against risk, increased about 1%.

"Today’s market reaction to the inflation report will make it hard to attract any investor who is still on the sidelines," Moya wrote. "The risks on Wall Street are growing and now include a Fed policy mistake, liquidity and credit risks, and growth concerns."

He added that bitcoin "remains very vulnerable to further selling pressure and could see further technical selling if the $28,500 level breaks."

Markets

S&P 500: 3,935 -1.6%

DJIA: 31,834 -1%

Nasdaq: 11,364 -3.1%

Gold: $1,852 +1%

Insights

Algorithmic stablecoins may not be such a great idea

LUNA and UST, the token and stablecoin of Singapore-based Terraform Labs, continued spiraling as UST’s key design imploded and trader sentiment around LUNA plummeted.

The impact wasn’t limited to niche regions of the internet either, as suicide helplines trended on community forums centered on Terra.

UST, a stablecoin pegged to U.S. dollars, fell to as low as 28 cents on Wednesday despite being backed by the likes of big-name crypto venture funds such as Three Arrows Capital and the Luna Foundation Guard (LFG).

The de-pegging, however, was unsurprising. Several algorithmic stablecoins have failed over the past two years and none have thrived.

Examples include Iron Finance and its TITAN tokens, Basis Cash, Empty Set Dollar, Dynamic Set Dollar and many more. These equated to millions of dollars in losses for investors.

Algorithmic stablecoins like UST are backed by a basket of assets, such as LUNA and bitcoin (BTC), without depending on any centralized third party to hold those assets. This is unlike tether and USD coin, whose parent firms claim to hold actual dollars in bank accounts to sufficiently back the values of USDT and USDC, respectively.

Tokens such as UST depend on LUNA to maintain a price of $1 using a set of on-chain mint and burn mechanics. Traders can always swap $1 worth of UST for $1 worth of LUNA and vice versa – with LUNA’s growing value serving as a shock absorber for UST's price.

However, the mechanism of algorithmically-governed stablecoins like UST makes them susceptible to the colloquial bank run.

As an example, consider Terra’s LUNA and UST tokens. A sudden fall in LUNA prices affects UST's entire stabilizing mechanism because users can no longer redeem their $1 of UST for $1 of LUNA. This creates a downward spiral as falling UST prices affect sentiment around LUNA, and a LUNA sell-off leads to lower UST prices.

A case in point is Wednesday’s price action. LUNA fell below $6 – a 96% drop since Tuesday – while UST slumped to 28 cents.

Analysts and market observers say algorithmic stablecoins remain a cause for concern now.

“Algorithmic stablecoins we see on the market today are innately brittle due to their design,” said Kate Kurbanova, cofounder of risk management platform Apostro, in a Telegram chat. “They try to hold the peg by using different algorithms, market incentives, and so on – but nevertheless, they are highly vulnerable and rely on the market and reference asset price.”

“However, such experiments work as there is a demand for stablecoins – especially when it comes to juicy APY,” Kurbanova added, reasoning their popularity.

The takeaway? Retail participants should perhaps stay away from algorithmic stablecoins that aren’t ready for prime time just yet, as the many failed experiments (and dollar losses) prove. It’s not like the crypto market isn’t enough of a risky asset class already.

Technician's take

CoinDesk - Unknown

Bitcoin daily chart shows support/resistance, with RSI on bottom. (Damanick Dantes/CoinDesk, TradingView)

Bitcoin (BTC) is down by 6% over the past 24 hours and is trading at the bottom of a year-long price range. The cryptocurrency could find support between $27,000 and $30,000, although negative momentum signals point to additional breakdowns.

The relative strength index (RSI) on the daily chart is deeply oversold, similar to what occurred on Jan. 24 of this year and May 20 of last year. Still, in a downtrend, oversold conditions can persist for a few weeks before an upswing in price occurs.

On the weekly chart, the RSI is the most oversold since March 2020, which preceded a strong rally. This time, however, long-term momentum has deteriorated, suggesting limited upside beyond the upper $40,000-$45,000 resistance zone.

For now, a relief rally could be brief, especially given the strong break below $35,000 last week.

Important events

9 a.m. HKT/SGT(1 a.m. UTC): Australia consumer inflation expectations (May)

1 p.m. HKT/SGT(5 a.m. UTC): Japan eco watchers survey current/outlook (April)

2 p.m. HKT/SGT(6 a.m. UTC): UK trade balance (March)

CoinDesk TV

In case you missed it, here is the most recent episode of "First Mover/" on CoinDesk TV:

The crypto market sell-off continued as the algorithmic stablecoin UST failed to recover its peg to the U.S. dollar. "First Mover" had markets analysis and the latest developments in the UST crisis. Guests included David Lawant of Bitwise Asset Management, ADM Investor Services International Chief Economist Marc Ostwald and Deribit Chief Commercial Officer Luuk Strijers

Headlines

The LUNA and UST Crash Explained in 5 Charts: One of the earliest signs that things were going wrong for Terra came when UST deposits on Anchor started dropping Saturday.

'$DAI Will Die' Tweet Twisted Back on Terra's Kwon as UST Loses $1 Peg: Terra's UST briefly fell below $6.5 billion in market cap on Wednesday morning, allowing DAI to be the fourth-biggest stablecoin on the market for a time.

Arrington Capital Scrubs $100M Anchor Yield Fund From Website After UST Upheaval: Founder Michael Arrington cited decreased demand for the decision to remove the fund from the company's website.

Coinbase's Q1 Revenue Misses Estimate as Trading Volume Drops: The U.S. crypto exchange's trading volume declined 44% from the fourth quarter.

UST’s Bitcoin Reserve Too Late in Coming to Save Dollar Peg: Luna Foundation Guard’s billions of dollars in bitcoin without an actual infrastructure ready to deploy left Terra’s stablecoin UST vulnerable to a "Soros-style attack," an analyst said.

UST Stablecoin Loses Dollar Peg for Second Time in 48 Hours, LUNA Market Cap Falls Below UST's: The development comes after the Luna Foundation Guard announced that its massive bitcoin reserves will be used to defend UST’s dollar peg.

Longer reads

Bitcoin Payments Remain in Their Infancy but There Are Green Shoots Everywhere: Can cryptocurrencies, stablecoins and CBDCs coexist as methods of payment? Industry leaders shine a light on the future of crypto payments. This piece is part of CoinDesk's Payments Week.

Today's crypto explainer: What Is Bitcoin?

Said and heard

"Several current and former [Federal Reserve] officials have suggested in recent days that, in hindsight, the central bank should have reacted more quickly and forcefully last fall, but that both profound uncertainty about the future and the Fed’s approach to setting policy slowed it down." (The New York Times) ... "A recent survey of more than 13,000 businesses by Russia's central bank revealed that many are experiencing problems bringing goods such as microchips, car parts, packaging or even buttons, into the country as a result. Shortages of raw materials or parts are forcing some firms to temporarily close factories or to look elsewhere." (BBC) ... "Individuals’ willingness to backstop markets throughout this year’s sell-off demonstrates that the group – for now – has been more resilient than analysts and trading professionals anticipated." (The Wall Street Journal)



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CoinDesk - Unknown

Shaurya is an analyst/editor for CoinDesk's markets team in Asia.

CoinDesk - Unknown

Damanick is a crypto market analyst at CoinDesk where he writes the daily Market Wrap and provides technical analysis. He is a Chartered Market Technician designation holder and member of the CMT Association. Damanick is also an equity/fixed income portfolio manager and does not invest in digital assets.

CoinDesk - Unknown

James Rubin is CoinDesk's U.S. news editor based on the West Coast.

CoinDesk - Unknown

Shaurya is an analyst/editor for CoinDesk's markets team in Asia.

CoinDesk - Unknown

Damanick is a crypto market analyst at CoinDesk where he writes the daily Market Wrap and provides technical analysis. He is a Chartered Market Technician designation holder and member of the CMT Association. Damanick is also an equity/fixed income portfolio manager and does not invest in digital assets.

CoinDesk - Unknown

James Rubin is CoinDesk's U.S. news editor based on the West Coast.

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