Economist Writing Every Day

Last month I posted on “The Different Classes of Crypto Stablecoins and Why It Matters “.  The main point there is that some so-called stablecoins (e.g., USDC) maintain their peg to the dollar by holding a dollars’ worth of securities (preferably U.S. treasury notes) for each dollar’s worth of stablecoin. This mechanism requires some centralized issuer to administer it. As long as said issuer is honest and transparent, this should work fine.

Crypto purists, however, prefer decentralized finance (de-fi), where there is no central controlling authority. Hence, clever folks have devised stablecoins which maintain their dollar peg through some settled algorithm which operates more or less autonomously out on the web; various other coins or assets are automatically bought or sold, or created/destroyed in order to keep the main stablecoin value more or less fixed versus the dollar. We warned that this type of stablecoin is “potentially problematic”; it is the sort of thing which works until it doesn’t.

In 2018 the Terra project was launched by Do Kwon and others.  The Terra stablecoin (UST) was designed to “maintain its peg through a complex model called a ‘burn and mint equilibrium’. This method uses a two-token system, whereby one token is supposed to remain stable (UST) while the other token (LUNA) is meant to absorb volatility.” Terra grew very rapidly, to become something like the fourth largest stablecoin at over $30 billion in capital value. As the supply of Terra increased, the market value for LUNA also increased. Many investors bought into LUNA and for a while were making big bucks as its value soared. A headline from February read, “LUNA shines with a 75% surge in February as $2.57 billion is delisted.”  Woo-hoo! And this headline from May 10  proclaimed, “Terra Ecosystem is the strongest growing ecosystem in 2021.”

However, just as that laudatory article was hitting the internet, Terra/Luna blew up. I am not clear on the exact sequence of events, especially on whether the catastrophe was a result of just some accidental market fluctuation or of deliberate dumping by some party who was positioned to benefit. In any event, the value of Terra quickly dropped from $1.00 to around $0.61, which triggered the issuing of vast amounts of LUNA, which cratered its value by some 98%. Since Luna was mainly what backed Terra, this was a positive feedback death spiral. This is same way the $2 billion IRON stablecoin imploded in June, 2021: a “stablecoin” was backed by an in-house crypto token whose value depended on more people buying into the system. Ponzi scheme, anyone?

Both Terra and LUNA got delisted from major exchanges for several days. As of today, the value of Terra (UST) is about ten cents.  Poof, there went some $40 billion  of investors’ money, just like that. Do Kwon is under police protection in Seoul after a man who lost $2.3 million in Terra/Luna tried to break into his home to demand an apology.

And this just in today: “DEI becomes latest algorithmic stablecoin to lose $1 peg, falling under 70 cents  “. Ouch. Looks like the federal regulators will be swarming the stablecoin space, or at least we may get some grandstanding Senate hearings out of it.

In other news, transactions connected to the insanely (I chose that word deliberately) popular and costly Bored Ape Yacht Club NFTs overwhelmed the Ethereum transaction network about two weeks ago; this is kind of a big deal because a whole lot of de-fi and other blockchain applications depend on Ethereum as the backbone of their transactions:

When Bored Ape Yacht Club creators Yuga Labs announced its Otherside NFT collection would launch on April 30, it was predicted by many to be the biggest NFT launch ever. Otherside is an upcoming Bored Ape Yacht Club metaverse game, and the NFTs in question were deeds for land in that virtual world. Buoyed by the BAYC’s success — it costs about $300,000 to buy into the Club — the sale of 55,000 land plots netted Yuga Labs around $320 million in three hours.

It also broke Ethereum for three hours.

Users paid thousands of dollars in transaction fees, regardless of whether those transactions succeeded. Because the launch put load on the entire blockchain, crypto traders were unable to buy, sell or send coins for hours. The sale highlights the growing profitability of the NFT market but also the uncertainty around whether blockchains are robust enough to handle the attention.

… Because the Otherside mint impacts the whole Ethereum blockchain, people doing completely unrelated things like selling ether or trading altcoins would also have to pay huge fees and wait hours for their transactions to clear. Someone tweeted a picture of them trying to send $100 in crypto from one wallet to another, showing it required $1,700 in gas fees.