Cryptocurrency TerraUSD Plunges as Investors Bail

A stablecoin, this breed of cryptocurrencies, had gained favor among traders for being the one part of the crypto universe that was known for its stability. While the most popular stablecoins maintain their levels with assets that include dollar-denominated debt and cash, TerraUSD is what is known as an algorithmic stablecoin, which relies on financial engineering to maintain its link to the dollar.

The break in TerraUSD’s peg began over the weekend with a series of large withdrawals of TerraUSD from Anchor Protocol, a sort of decentralized bank for crypto investors.

Anchor Protocol is built on the technology of the same Terra blockchain network that TerraUSD is based on. It had been a major factor in the growth of the stablecoin in recent months by allowing crypto investors to earn returns of nearly 20% annually by lending out their TerraUSD holdings.

At the same time, TerraUSD was also sold for other stablecoins backed by traditional assets through various liquidity pools that contribute to the stability of the peg, as well as through cryptocurrency exchanges. The sudden outflow of money spooked some traders who began selling TerraUSD and its sister token Luna. Before its peg was broken, TerraUSD was the third largest stablecoin with a total market value of $18 billion.

The sudden outflow of money in recent days spooked some traders who began selling TerraUSD and its sister token Luna.

TerraUSD’s fall to 23 cents at around 3:30 a.m. ET marked a 70% plunge from its value 24 hours earlier, according to CoinDesk. Luna briefly touched a low of $4.10—an 85% plunge over the same period.

Stablecoins have surged in popularity the past two years and now act as the grease that moves the gears of the cryptocurrency ecosystem. Traders prefer to buy coins such as bitcoin, ether and dogecoin using digital assets that are pegged to the dollar because when they buy or sell, the price is only moving on one side. They also allow for fast trading without the settlement times associated with government-issued currencies, which can take days.

The price of bitcoin rose to $31,336.50 Wednesday, up 1.2% from its 5 p.m. ET level Tuesday. It has lost about 21% of its value over the past week alone.

In the past, TerraUSD maintained its $1 price by relying on traders who acted as its backstop. When it fell below the peg, traders would “burn” the stablecoin—removing it from circulation—by exchanging TerraUSD for $1 worth of new units of Luna. That action reduced the supply of TerraUSD and raised its price.

Conversely, when TerraUSD’s value rose above $1, traders could burn Luna and create new TerraUSD, thus increasing the supply of the stablecoin and lowering its price back toward $1.

Such a model has drawn criticism because it relies on people’s collective willingness to support the cryptocurrency. Without that, the stablecoin can quickly sink, in what industry participants have described as a “death spiral.”

Martin Hiesboeck, head of blockchain and crypto research at digital money platform Uphold, compared what’s happening with TerraUSD and Luna to a bank run. “People don’t trust it anymore, they’re running for the exit,” he said.

TerraUSD was created by Do Kwon, a South Korean developer who also co-founded the Luna Foundation Guard, a nonprofit that has been helping to support TerraUSD and maintain its peg.

Earlier this week, the foundation said it lent $750 million of bitcoin to trading firms to protect the stablecoin’s peg. Blockchain records of the foundation’s wallet show that it no longer holds bitcoin in that account.

The previous day, TerraUSD’s value had rebounded to around 90 cents after falling to 61 cents, while Luna had also recovered after plunging.

Write to Caitlin Ostroff at [email protected] and Elaine Yu at [email protected]