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Terra hasn’t killed crypto, but it was a narrow escape

Prior to losing its peg on May 8, TerraUSD had a total market value of around $18.6 billion.

Speculation that the collapse of one of the biggest experiments in decentralised finance could bring about the death of crypto appears to have been overblown. If Terra’s implosion had happened after a few more months of growth, the resultant market impact might have created a DeFi version of 2008 — instead, high-profile algorithmic stablecoins may end up being the main casualty.

In a tumble starting on May 9, Terraform Labs’ TerraUSD — a token that primarily uses algorithms, rather than collateral, to adjust its supply and maintain a 1-to-1 peg with the US dollar — and its digital coin counterpart Luna lost almost all their value, while activity on the underlying Terra blockchain was twice suspended. A month after reaching a record of $119, the price of Luna now trades at near zero, while UST is stuck around 20 cents.

The meltdown sparked crypto price declines across the board; they later stabilized and recovered somewhat, but not without knocking some $300 billion or so off of the sector’s trillion-dollar total market value. Most significantly, it caused wobbles in even the largest collateralised stablecoins, which back their peg with dollar and dollar-equivalent assets — though they too returned to business as usual by the end of the week.

Stablecoins are a vital part of crypto because they are used by traders as a means of retaining value without leaving the digital asset ecosystem. Investors turn to them as a safe haven during periods of volatility, or even simply as a means of digital payment. Now, questions remain on whether the unique mechanism behind TerraUSD might be entering retirement, at least for use by projects that get too big to fail.

“I wouldn’t be surprised if this is the end of algorithmic stablecoins,” said Hilary Allen, professor of law at American University.

“DeFi can’t work without stablecoins, really. A lack of trust in stablecoins would be catastrophic for the DeFi ecosystem.”

Prior to losing its peg on May 8, TerraUSD had a total market value of around $18.6 billion — dwarfed in size by its collateralised rivals Tether and USDC, at $83.2 billion and $48.7 billion, respectively, according to data from CoinMarketCap. That kept its collapse from causing lasting widespread contagion, but any later, and it might have been a different story.

Price of failure
As the Terra ecosystem grew in popularity, its co-founder Do Kwon said he wanted to build a reserve that might shore up UST in times of extreme stress. He established the Luna Foundation Guard, an organization aimed at keeping UST stable, which would look after a pile of Bitcoin he was slowly accumulating to act as collateral for UST. Meanwhile, developers continued to build apps on its blockchain, investors bet on its future and some crypto luminaries irrevocably tied themselves to the project.

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