Is Crypto Market Maturing?
Pandemonium, as the collapse of Terra, creates fear that the crypto sector may face existential concerns.
Cryptocurrencies have had an exceptional year, reaching a combined value of more than US$3 trillion (£2.2 trillion) for the first time in November. The market seems to have benefited from the public having time on their hands during pandemic lockdowns.
Also, significant investment funds and banks have stepped in with the recent launch of the first bitcoin-backed ETF – a listed fund that makes it easier for more investors to get exposure to this asset class.
Alongside this has been an explosive rise in the value of stablecoins like Tether, USDC, and Binance USD. Like other cryptocurrencies, stablecoins move around on the same online ledger technology known as blockchains. The difference is that their value is pegged 1:1 to a financial asset outside the world of crypto, usually the US dollar.
Stablecoins enable investors to keep money in their digital wallets that are less volatile than bitcoin, giving them one less reason to need a bank account. For a whole movement about a declaration of independence from banks and other centralized financial providers, stablecoins help facilitate that. And since the rest of crypto tends to go up and down together, investors can protect themselves better in a falling market by moving money into stablecoins than selling their ether for bitcoin.
A substantial proportion of buying and selling of crypto is done using stablecoins. They are beneficial for trading on exchanges like Uniswap, where there is no single company in control and no option to use fiat currencies. The total dollar value of stablecoins has shot up from the low US$20 billion a year ago to US$139 billion today.
In one sense, this is a sign that the cryptocurrency market is maturing, but it also has regulators worried about the risks that stablecoins could pose to the financial system. So what’s the problem, and what can be done about it?
This week, billions were wiped off the cryptocurrency market with the terra “stablecoin” collapse. But is its failure just another example of the here-today-gone-tomorrow nature of the sector, or could it be the beginning of a broader downturn?
The near-total crash of Terra has fuelled real panic that the crypto sector may face existential problems.
- One Tether token is always supposed to be traded at $1.
Shockwaves swept through cryptocurrency markets on Thursday as Tether, the most prominent “stablecoin” and a foundational part of the digital asset ecosystem, broke its peg to the dollar in the latest blow to the struggling sector.
Bitcoin and ethereum, the two biggest cryptocurrencies, shed 5% and 12%, respectively, extending losses that have seen both fall more than 20% over the past week. Losses have been even more significant for the smaller players, with dogecoin falling 10% on Thursday and 35% over the week.
The losses came as Tether traded at less than $0.98 for the first time in two years on Thursday morning, prompting it to assure investors it was still capable of honoring withdrawals at par.
Like all stablecoins, Tether is intended to only trade at a fixed value relative to a conventional currency: one tether token is always supposed to be $1.
Prominent Stablecoin, Terra
However, on Monday, another prominent stablecoin, Terra, broke its peg to the dollar and has slumped since now, trading at barely half its supposed stable value. That appears to have precipitated a more comprehensive crash, with even the blue-chip cryptocurrencies plummeting over the past week.
“There is a definite whiff of panic in the crypto space right now amid the stablecoin collapse,” said Neil Wilson of Finalto.
Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, said: “The terra incident is causing an industry-based panic, as terra is the world’s third-biggest stablecoin.”
The most prominent cryptocurrency, Bitcoin, was trading at $29,368 on Thursday, giving it a total value of $562bn, compared with its peak of more than $1tn last year.
The selloff has taken the combined market value of all cryptocurrencies to $1.2tn, less than half of where it was last November, based on data from CoinMarketCap.
It has also hit crypto billionaires. The fortune of Changpeng Zhao, the founder of the Binance cryptocurrency exchange, has fallen from $84bn this year to $11.5bn.
In contrast, Tyler and Cameron Winklevoss, cofounders of the rival Gemini exchange, have lost more than $2bn each this year.
The founder of the Coinbase exchange, Brian Armstrong, is now worth $2.2bn, down from $13.7bn in November last year, according to the Bloomberg Billionaires Index. Coinbase is suffering, with its stock trading down 60% over the previous five days.
It has been hit by the general slump in the tech sector, blowback from the crypto collapse, and its problems. The company prompted panic among its users with a legally mandated disclosure that, if it goes bankrupt, customer deposits are not protected in the same way bank deposits are.
The digital currency jitters come amid a broader downturn in the US economy, with tech stocks sliding and US inflation at 8.3%. However, unlike previous downturns, where crypto has largely tracked wider weaknesses and recoveries, the near-total collapse of Terra – valued at $30bn last week and now trading at less than $300m – has fuelled real panic that the sector may face existential problems.
Tether has particular concerns because of its foundational role in the financial engineering of much of the sector and the fact it holds reserves in other cryptocurrencies, leading to fears of contagion if it collapses.
Unlike Terra – which maintains its value via a complex algorithm – Tether pledges that all its tokens “are backed 100%” by its reserves, which were $80bn in its last report in December and included loans, precious metals, and investments in other crypto sector companies.
In theory, Tether should never trade below $1: any time it does, there is guaranteed profit from commercial arbitrageurs willing to buy the token at a discount and return it to Tether, which pledges to buy it from them at total value.
However, since Terra’s collapse, there has been such a rush of selling across the entire sector that the market value of Tether fell as low as 95¢ before recovering. Public records show at least one large redemption removed almost $350m from the reserves.
As redemptions increase, the company could be forced to call in its loans to other crypto companies, causing them to suffer financially. And if it collapses entirely, large chunks of the industry will stop working, as they rely on the tether token to keep prices stable relative to the US dollar.
In a statement, the Tether company said it was “business as usual amid some expected market panic” and had processed $2bn of withdrawals. That represents about half of the company’s cash on hand.
Its chief technology officer, Paolo Ardoino, said: “Tether is gratified that the market shows its trust and confidence in Tether: the first, largest, and most transparent, innovative, and liquid stablecoin. We are a quickly evolving industry, and as an industry, we will learn from these events together.”
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