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Stablecoins: Why They Crashed And What It Means For Crypto

Popular cryptocurrencies like bitcoin and ethereum have seen prices drop in recent weeks, but stablecoins are also having their moment in the spotlight, and for all the wrong reasons.

TerraUSD, a prominent stablecoin, broke its parity with the dollar and is now trading at near zero, which has precipitated a broader decline and even blue chip cryptocurrencies are suffering.

Bitcoin is trading below $30,000 compared to its peak of over $60,000, while Ethereum is trading just over $2,000.

Market crash: Popular stablecoin Tether experienced a short-lived meltdown last week when its value fell below $1

Market crash: Popular stablecoin Tether experienced a short-lived meltdown last week when its value fell below $1

The significant drop in TerraUSD, which is backed by an algorithm rather than real assets, has led people to consider the future of stablecoins more generally.

We take a look at what caused a crash and what it means for stablecoins and the crypto market in general.

What are stablecoins and how do they work?

A stablecoin is a type of cryptocurrency that is pegged to real-world assets like the US dollar.

They were developed in part in response to the volatility seen in other cryptocurrencies like bitcoin, whose value is constantly fluctuating, but now stablecoins are starting to crash.

They are based on blockchain technology similar to cryptocurrencies, but are designed to offer more stability.

There are stablecoins backed by cryptocurrencies and precious metals, but the most common tend to be fiat-backed stablecoins, which are backed by government-issued currency.

Then there are the algorithmic stablecoins that are not backed by any assets. They use a computer algorithm to prevent the value from fluctuating too much. You can issue more coins when their price goes up and buy them from the market when the price goes down again.

Traders tend to buy stablecoins that are accepted on crypto exchanges and then use them to buy and sell other cryptocurrencies more quickly.

Tether is the largest stablecoin: it is pegged one-to-one to US dollars and says it is fully backed by its asset reserves which include US government bonds, corporate debt and a small amount of cash.

Stablecoins developed in part in response to the volatility seen in other cryptocurrencies like bitcoin, but as last week demonstrated, they are not without risk.

Why was TerraUSD blocked?

Where TerraUSD differed was that it was backed by an algorithm rather than actual US dollars.

The algorithm would adjust the supply of Terra USD through another token, Luna, to keep its value pegged to the dollar.

This stopped working when Luna’s value fell to almost zero, adding pressure to an already tumultuous time in the cryptocurrency market.

Traders say this was triggered by a series of large withdrawals from Anchor Protocol, a platform built at Terraform Labs, the company behind the token.

These transactions led more and more investors to withdraw their TerraUSD from Anchor and sell the coin.

The reserve fund of around $3 billion worth of bitcoin and other cryptocurrencies, which is owned by Luna Foundation Guard, a non-profit organization co-founded by Terraform founder Do Kwon.

The sale of this amount of bitcoin contributed a bit to the drop in the price of bitcoin last week, according to analysts.

Do Kwon, co-founder of Terraform Labs, the company behind the token, announced a “recovery plan” in a series of tweets last week.

The company will now seek additional financing and rebuild TerraUSD. The token will be backed by reserves instead of relying on an algorithm.

What does it mean for the markets?

Tether, the most popular stablecoin that is backed by real assets, faced a short-lived crisis last week when its value fell from $1 to 95 cents.

It has since recovered, but has raised questions about stablecoins and the regulation around cryptocurrencies.

Traditional financial markets have seen little effect from the cryptocurrency crash. Ratings agency Fitch said last week that weak ties to regulated markets limit the potential for cryptocurrency volatility to cause broader financial instability.

However, central bankers have raised concerns that the collapse of a stablecoin could have broader implications for traditional financial markets.

Treasury Secretary Janet Yellen warned that the drop in Terra’s value showed that stablecoins were a “fast-growing commodity and that there are risks to fast-growing” and the US Federal Reserve warned that stablecoins they are vulnerable to runs because they are backed by assets in times of market volatility.

Martha Reyes, head of research at cryptocurrency brokerage firm BEQUANT, said: “Markets are crashing, but this may present an opportunity for institutional players to start building positions and push stablecoin regulation to provide more confidence. “.

“While we may not bottom out and correlations between asset classes remain high, Bitcoin has survived 70-80 percent corrections in the past. This may be an opportunity for institutions to build positions at higher levels.

“Uncertainty around stablecoins is a concern and could lead to another exit, but we can finally get the much-needed regulatory framework that could attract institutions. Regulators tend to be reactive so this may be the catalyst.” for further regulation of stablecoins.”

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