Stablecoins are struggling to survive the crypto crash

Illustration by Alex Castro

It has been a rough week for the Terra project, with a few days that have been crushing.

The TerraUSD stable coin dropped to a low of less than 30 cents on May 10th, after a few days of being uncoupled from the $1 mark. In the latest update to the saga, the project froze user funds for two hours on Thursday until the block was unpaused.

The Terra blockchain was officially halted at a block height of 7603700.https://t.co/squ5MZ5VDK



Terra validators have decided to halt the Terra chain to prevent governance attacks following severe $LUNA inflation and a significantly reduced cost of attack.

— Terra (UST) Powered by LUNA (@terra_money) May 12, 2022

We have seen hard forks before, but this is the first time we have seen such a large system decide to halt.

The chaos was caused by a steep slide that wiped out $200 billion in value in a single day. On the morning of May 12th, a price not seen since December 2020 and less than half of its peak in November 2021, the price of all cryptocurrencies fell to below $25,000. The other cryptocurrencies have suffered similar losses in a short period of time, with Ethereum losing 20 percent of its value in 24 hours.

On May 9th, the price of the UST stablecoin plummeted. Because of the way that stable coins operate, there was a huge increase in the supply of the corresponding Luna token, which was traded against UST in order to balance the price.

Adding Luna token into circulation or removing them was enough to maintain a consistent price. The death spiral that has been created by the size of the price slide and the corresponding amount of Luna has been caused by the two linked cryptocurrencies.

The value of Luna has plummeted from $100 to around 1 cent, as UST is trading at 40 cents instead of $1.

Image: CoinMarketcap

Terra's nightmare week shows that stable coins can be affected by larger market movements and affect those movements in turn.

Terra isn't the only stable coin facing problems. The price of theUSDT stablecoin sank below its dollar peg on some exchanges on Thursday, but recovered to trade at 95 cents on some exchanges. The events did not pose a significant risk to financial markets as a whole, as Treasury Secretary Janet Yellen reassured the US House Committee on Financial Services.

Stable coins are still experimental, and the sudden drop is a reminder.

Terra's future is uncertain, but the sheer volume of unredeemed Terra coins presents a huge problem for the project. As more coin-holders try to cash out, they are likely to devalue the supply of Luna token even further, creating a death spiral.

Gu is cautiously optimistic about the future of stable coins.