TerraUSD (UST) is an algorithmic stablecoin that is pegged at $1.00. But, on the evening of May 19, it was trading for $0.083.
This isn’t supposed to happen, of course, but last week UST, along with its affiliated coin Terra (LUNA), performed a sort of death spiral that “wiped nearly $50 billion of investor wealth in a few short days,” according to NYDIG’s May 13 newsletter.
The crash shook the crypto sector, but it also raised some questions: Is this about a single flawed project or is it also about an entire class of cryptocurrencies — algorithmic stablecoins — which use an arbitrage mechanism instead of fiat reserves to keep their market price stable? That is, are algo stables inherently unstable?
Also, how have last week’s events affected more traditional stablecoins, like Tether (USDT), the industry’s largest, but which also briefly lost its 1:1 peg to the United States dollar? And, what about implications for the cryptocurrency and blockchain space generally — has it too been tarred by UST’s fall?
Finally, what lessons, if any, can be drawn from the week’s tumultuous events so that this doesn’t happen again?
Can algo stables survive?
As the dust settles, some are asking if the UST/LUNA flatlining spells the beginning of the end for algorithmic stablecoins as a class. For the record: Some algo stables, including UST, may be partially collateralized, but algo stables rely mainly on market maker “arbitrage” activity to maintain their $1.00 market price.
Pure algo stables, which put up no collateral at all, are “inherently fragile,” according to Ryan Clements, assistant professor at the University of Calgary Faculty of Law. They “rely on numerous assumptions for operational stability, which are neither certain nor guaranteed.” As he further explained to Cointelegraph:
“Specifically, they require ongoing demand, willing market participants to perform arbitrage and reliable price information. None of these are certain and all of…
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