Conceptualizing The Chaos

Welcome to crypto!

For those not paying attention, the crypto market has been in a downward spiral ever since the collapse of both TerraUSD (UST), an algorithmic stablecoin, and its counterpart, Terra (LUNA).

We highlighted the carnage in our issue last week as we waited for the dust to settle.

Today, we can finally begin to make sense of it all…

So What Caused The Terra/Luna Blowup?

To be honest, we don’t have enough space (or patience) in this newsletter to breakdown all the compounding events that ultimately led to the Terra/Luna collapse.

The details are utterly confusing for your common investor and, as it turns out, the rumor mill is still churning in regards to what exactly triggered it.

But to quickly sum it up, Terra/Luna was in a category of its own, relying solely on its algorithmic mechanism. It was a creative albeit risky model from the start that many predicted might fail.

(For those who want to dive a little deeper, this is one of the best summaries we found that explains what happened with Terra/Luna, in laymen terms)

What Does This Mean For The Market?

Many fail to realize this wasn’t just another ponzi-like cryptoasset imploding. LUNA was the third largest DeFi token, and both LUNA and UST were in the top 10 largest tokens by market cap before all of this happened. Furthermore, Terra/Luna was also deeply integrated into the rest of the crypto economy. It was held in exchanges all over the map. It was tapped with loads of institutional investment. And tons of funds, startups, and retail investors had exposure to it.

The ripple effects of the collapse smacked the entire crypto market in the face. Since May 5th, $570 billion has been wiped from the market with crypto’s total market cap falling from $1.81 trillion to 1.24 trillion. Not to mention, today’s falling stock market hasn’t helped either, with crypto/traditional markets being more correlated than ever.

What Does This Mean For Other Stablecoins?

The crypto markets are still assessing the aftermath of the Terra/Luna collapse, but one immediate effect has been a drawdown in stablecoin liquidity within DeFi. According to Coin Metrics, the amount of USDC held in smart contracts on Ethereum has fallen by about $5 billion since its peak in March. Similarly, the supply of DAI – another widely used stablecoin – has also fallen about $2 billion. Another ripple effect was Tether (USDT) – the largest stablecoin today by total supply – briefly losing it’s peg late last week, causing even more panic as the investors rushed back into fiat.

Although the Terra/Luna may spell the end of algorithmic stablcoins as we know it, traditional stablecoins (those backed by cash and cash equivalents) whether you like them or not, will continue to be a critical part of the crypto ecosystem. Regardless, it’s fair to state that stablecoins will undoubtedly succumb to more scrutiny in the coming months.

Our (Hot) Take:

Call it what you want, but had you only read CoinSnacks, you probably wouldn’t be a part of this mess. You see, there’s a reason we tend to stick the basics (i.e. bitcoin, ethereum, crypto/institutional adoption, the macroeconomic implications of crypto, etc.). It’s because we can make sense of it.

The rabbit holes into DeFi, algo stablecoins, and the thousands of altcoins involved come with a double edged sword. Yes, many of these things are groundbreaking and innovative and do serve a purpose to some extent in the world of decentralized finance and banking. But many folks fail to realize just how speculative these projects are. Since its inception, the DeFi space has again and again reminded us of the ICO boom in 2017; copied over whitepapers, endless shilling, deceptive marketing, exchanges listing everything under the sun to drive more fees… the list goes on and on. But most importantly, we saw the retail crowd rush into these assets without any foundational understanding of how DeFi actually operates.

As the saying goes, the important thing is to know what you know and know what you don’t know. In other words, stop putting your capital in things you don’t understand.