As the crypto industry reels from the aftershocks of last week’s historic collapse of Terra’s stablecoin, UST, and native token, LUNA, a number of important names in the crypto space have emerged to offer their perspectives.
Ethereum (ETH) creator Vitalik Buterin took to Twitter to criticize the entire premise of uncollateralized and peg-deviating algorithmic stables like UST – whose mechanism is designed to encourage users to engage in arbitrage activities whenever the peg diverges – citing it as misleading by design and intrinsically flawed.
“‘Algostable’ has become a propaganda term serving to legitimize uncollateralized stables by putting them in the same bucket as collateralized stables like RAI/DAI,” Buterin tweeted.
Agree hard on this, with the one quibble that "algostable" has become a propaganda term serving to legitimize uncollateralized stables by putting them in the same bucket as collateralized stables like DAI/RAI, and we need to really emphasize that the two are very different.
— vitalik.eth (@VitalikButerin) May 14, 2022
On May 9, the value of UST and LUNA collapsed, wiping out some $11 billion in market cap. The cause? A burning/minting mechanism designed to keep UST at $1, failed.
UST isn’t backed by cash or assets like other leading stablecoins, so when the algorithm tying UST’s value to LUNA broke down, there was nothing to support the cryptocurrency. As a result of the stable’s de-pegging and further LUNA decline, investors lost everything.
Do Kwon, the founder and CEO of Terra, has throughout the crisis kept in his Twitter bio: “Master of Stablecoin.” Terra’s primary selling point to investors was that it was just as stable as asset-backed stablecoins, if not more so.
In fact, UST’s peg premise was for it to stay as close to $1 as possible and never fluctuate plus or minus one penny. But on May 9, the same day that the price of Bitcoin (BTC) plunged 9.5%, UST tanked 23%. The next day it recovered somewhat to only start declining a day later. In the space of 48 hours, Terra lost 99% of its value.
For a self-proclaimed “Master of Stablecoin,” that’s not a great track record.
“We need to emphasize that [algorithmic and asset-backed stablecoins] are very different,” Buterin said.
Algorithmic stablecoins are a new breed of digital asset, designed to maintain a stable value regardless of market conditions. Asset-backed stablecoins, on the other hand, are backed by physical assets such as fiat currency or gold. While both types of stablecoins offer similar benefits, they differ in terms of how they maintain their value.
Algorithmic stablecoins use complex algorithms to peg their value to a specific asset, while asset-backed stablecoins rely on the underlying asset to maintain their value. As a result, asset-backed stablecoins are less likely to experience fluctuations in value due to changes in the underlying asset, while algorithmic stablecoins are designed to be more prone to such fluctuations.
While Buterin’s comments may be harsh, they raise some valid concerns about the long-term viability of algorithmic backed stables.
It goes without saying that while UST and LUNA may be gone, the lessons learned from this experience will be valuable for years to come. For now, though, it’s a cautionary tale about the risks of investing in unbacked cryptocurrencies.
LUNA lost 32% during today’s trading and changed hands at $0.0002, according to data from Coinmarketcap.
Less than two weeks ago, on May 4, 2022, the crypto was trading at nearly $90.00 per coin.
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