Crashes like the Terra Luna collapse make headlines, but don’t doom the crypto space just yet
5 min read
The spectacular meltdown surrounding the Terra stablecoin and Luna governance token might be generating headlines, but it’s no indication that the broader crypto asset marketplace is headed for a collapse.
Stablecoins have quickly moved from a niche area of the crypto sector to a type of crypto asset that has been heralded by many as the best of both worlds.
By combining the functionality and price stability associated with fiat currencies with the speed, security, and lower fee structure of cryptocurrency stablecoins have – rightly so – experienced a dramatic increase in both interest and adoption.
TerraLabs, the parent organisation of the Terra stablecoin, seemed like just the latest entrant to this space, and appeared to have come up with an innovative solution to entice additional investment to the project: an algorithmic stablecoin.
Without diving into too much technical detail, the algorithm underpinning the Terra stablecoin was developed to address the fundamental problem with any stablecoin; how is the stabilisation maintained?
Usually designed to be traded and used as a 1:1 equivalent with the US dollar, stablecoin issuers attempting to achieve commercial scale and acceptance must have a process in place to maintain this valuation.
Dr Sean Stein Smith
The algorithm underpinning Terra enabled the automation of this process, versus manual pegging and adjusting the supply of stablecoins, with the aid of smart contracts and the Luna governance token.
For the purposes of this article, smart contracts can be summarised as executable code that is embedded and connected to a blockchain application.
When the price of Terra dipped below or rose above $1, these smart contracts would power the algorithmic process that allowed investors to swap Terra for Luna to either profit from the arbitrage opportunities and/or bring the price back into alignment.
An elegant solution, but one that failed catastrophically.
In addition to the abject failure of the Terra protocol, there has been a broader collapse in crypto prices at large, with Bitcoin – still the largest and most well-known crypto – dropping to levels not seen since the COVID-19 market selloff in Q1 2020.
Despite all of this, and fully acknowledging that the end of crypto has been heralded numerous times, some market actors are calling into question many of the very advancements that have led to broader adoption over the last several years.
Crypto markets might look ugly right now, but this is by no means the end of crypto.
Let’s take a look at a few of the reasons why crypto will come back stronger from this turmoil.
Stablecoins are here to stay
Privately issued stablecoins have been on the front-burner for regulators the world over, and this is not without reasonable cause.
In the United States alone, seemingly seeking to re-establish itself as a market innovator and leader in the space, stablecoin utilisation increased by 500 per cent between 2020 and 2021.
Dr Sean Stein Smith
Following this dramatic increase in volume, several major global payment processors (Visa, Mastercard, and PayPal) are either actively developing stablecoin offerings or are facilitating billions in crypto-denominated transactions.
Privately issued stablecoins generate many headlines, good and bad, but are also the starting point for how many organisations interact with the crypto space, and have provided a template inspiring the breakneck pace of central bank digital currency (CBDC) development.
No matter how this subset of the crypto space is analysed, stablecoins have an incredibly important role to play, and are here to stay.
Boring is cool again
As with any emerging technology there is a temptation to continuously add features, applications, and tools as the market advances.
TerraLabs might be the namesake of the Terra stablecoin, but counterparties such as Luna Guard Foundation and the Anchor Protocol community played prominent roles in the Terra ecosystem. Such complexity might very well be necessary to some extent, but building such a complicated underpinning requires that safeguards are up to the task.
Following the collapse in faith – and the price – of this ecosystem, the flaws in such an arrangement have been laid bare.
Specifically, the Terra ecosystem relied on two crypto asset applications that are still relatively nascent in terms of regulation; algorithmic stablecoins and decentralised finance.
As confidence in one faltered, this cascaded throughout the system, and even led to the recently acquired Bitcoin reserves to be sold, transferred, or otherwise used as a last-ditch effort to support this arrangement.
Regulation encourages adoption
As much as some market participants, reinforced by current market volatility and the failure of some projects, would like to paint the crypto asset space as an unregulated free-for-all, the truth is much different.
Virtually every regulatory body in the world is studying crypto asset regulation, engaging with market participants, and are seeking to develop standards that both protect users and encourage innovation.
This also highlights a point that, understandably so, can be overlooked as the crypto space continues to experience growing pains.
The entire blockchain and crypto asset space only came into existence in 2009, and really only came to the attention of mainstream financial markets in 2016; these are still very early days for investors, regulators, and developers alike.
Pain caused by this volatility is real, and no attempt should be made to downplay the economic harms that have occurred, but all of this is a part of how markets evolve. Due diligence, reasonable investing strategies, and diversification are still strategies that work quite effectively.
Crypto is a volatile and fast-moving space; that much is obvious. Recent volatility, price declines, and even the failure of some projects should not be seen as the end of the space.
Rather, it should be seen as a healthy shaking out of marginal projects and unsustainable ideas that will leave the sector better off for having gone through it.
- Dr Sean Stein Smith is an assistant professor at Lehman College, a strategic advisor at The Central Bank Digital Currency Think Tank in New York, and a regular contributor to Euronews Next
