Crypto investors no longer know where to turn.
Crypto pricing is now correlated with the stock market, which means that, as the saying goes, when the stock market coughs, digital-currency prices catch pneumonia.
This has persisted this year due to fears of recession. That concern in turn has been fueled by inflation, which is at its highest in 40 years, and by the continuing disruption of supply chains, most recently made worse as covid-19 resurged in China.
Investors have been liquidating assets, and almost no asset class is spared. But apart from this pessimistic overall picture, the crypto market also suffers from problems inherent in certain projects, such as stablecoins.
What Is a Stablecoin?
A stablecoin is a digital currency whose value is pegged to a stable reserve asset, like the U.S. dollar, the euro or gold. The goal is to offer investors a way to buy cryptocurrencies that are supposed to be stable, unlike unpegged cryptocurrencies like bitcoin or ether, which are very volatile.
Stablecoins are therefore supposed to be backed by assets in dollars or euros whose fair value must be at least equivalent to the number of coins in circulation.
“The value of cryptocurrencies like bitcoin and ether fluctuates a lot — sometimes by the minute,” Coinbase explained in a blog post. “An asset that’s pegged to a more stable currency can give buyers and sellers certainty that the value of their tokens won’t rise or crash unpredictably in the near future.”
Stablecoins are designed to bring peace of mind to investors who are still reluctant to invest in crypto. This principle had been holding up, but in recent days it’s been shattered by the collapse of the stablecoin UST or TerraUSD and its token sister Luna. Both are cryptocurrencies of the Terra ecosystem.
UST lost its dollar peg when millions of investors all wanted to redeem their tokens at the same time. The market then discovered that the UST reserve mechanism was fallible. Indeed, UST is an algorithmic stablecoin; In other words it is backed not by dollar reserves but rather by its sister asset Luna, which had to be burned, or permanently destroyed, through a computer code.
Algorithmic stablecoins are different from centralized alternatives like tether (USDT) or USD coin (USDC), which are backed by actual dollars or equivalent assets stored in a bank.
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‘One of the Largest Fiascos in Crypto’
The values of UST and Luna collapsed at once, causing colossal losses to millions of retail and large investors. Here you can read a story from TheStreet’s Rob Lenihan about investors who say they are on the verge of financial ruin because of UST and Luna.
“Terra’s demise is one of the largest fiascos in crypto-market history as measured by market capitalization affected relative to total crypto market cap,” Ark Invest analyst Frank Downing said in a note. “Compared to the Mt. Gox hack in 2014 that stole 7% of outstanding bitcoin, Terra’s collapse has destroyed roughly 3% of crypto’s total market capitalization.”
The market cap of the crypto market is currently at $1.38 trillion, far from the $3 trillion reached last November.
DEI Loses Its Peg to the Dollar
Now, another algorithmic stablecoin is in the spotlight. This is DEI, Deus Finance’s stablecoin. DEI operates within Deus, a decentralized finance project based on the Fantom ecosystem.
DEI has just lost its its 1-to-1 peg to the dollar. DEI is currently trading at $0.574049, down 11%, according to CoinGecko.
On May 16, prices fell to $0.525299. The coin had hit a high of $1.18 on Jan. 31 and had a market value of $114.8 million on April 30. But since then the market cap has melted by 55% to $51.3 million.
The project uses DEUS and DEI coins: To create, or mint, 1 DEI, you must have $1 of collateral.
When they want to redeem their tokens, investors get 80% of their value in USDC and 20% in DEUS if USDC was used as collateral to create DEI. The collateral ratio fell to 43%, Finbold.com reported, citing data from Deus Finance.
But low collateral makes redemption of DEI coins difficult, since not enough capital is backing the stablecoin.
“Traders are taking advantage of this arbitrage mismatch, buying up DEI coins and exchanging them for $1 worth of collateral, making matters worse,” Finbold.com said.
Deus Finance has now tried to stabilize the coin by suspending all redemptions.