#18 The Context: Unstablecoin Takes Us Into Terra Incognita
Also: What's behind the broader fall in crypto?
Hi, it's been a breathless week in DeFi as you might have noticed. Accordingly, we take a look at the big stories: the collapse of Terraform Labs’ stablecoin, as well as the broader crypto routs. We also try to pull a thread through some unrelated NFT stories.
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As usual, a disclaimer: This newsletter collates the interesting stuff in DeFi/crypto/metaverse/web3/NFT land and offers some context (hence the name). It’s aimed at anyone who wants to keep an eye on the space but isn’t following it too closely, or is on the hunt for story ideas and angles. It’s put together by a team at YAP, and doesn’t contain any promotion of our clients (if one is mentioned, we’ll flag that).
Shout-outs to Ruby Wu and Roslyn Tear, two of the members of the team putting this together.
Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
[tl;dr]
Stablecoin Terra, the crypto that isn’t supposed to move much, has also taken a massive hit. Some saw it coming. Why weren’t they heard — and what happens next?
Cryptocurrencies and NFTs more broadly have fallen too, with Bitcoin, for example, losing more than half its November value. Why, where, who, how?
And for those tired of rubber-necking: Are NFTs the missing adhesive to connect social and financial networks together?
[Stablecoin’s untethering]
The untethering of the UST stablecoin has been dramatic and has raised multiple questions. Terra’s UST is bound by an algorithm where traders and software programs are incentivised to swap UST for LUNA tokens and vice versa, keeping the UST at $1 or close to it. LUNA has fallen from more than $90 to less than 50 cents, at the time of writing. The drama has impoverished some and raised some difficult questions:
Aren't stablecoins supposed to be stable? “Algorithmic stablecoins, like their more “traditional” counterparts," according to Bloomberg, “are supposed to provide calm in the chaos of crypto. Instead, as investors in one such token are rapidly finding out, they can serve as lightning rods for volatility." Whatever triggered the run remains a source of debate, but the crisis of confidence underlining it challenges the idea of creating a stablecoin tethered not to underlying "real" assets but to active treasury management and software-encoded instructions. It may also be a wake-up call to retail investors who may not have understood all the risks connected to what looked like a safe bet.
Intervention? This kind of thing in the non-crypto world would be a situation where governments get involved, when some institutions are seen as "too big to fail," for fear of contagion, or the whole edifice collapsing. But in crypto there is no central entity, and the US government don't seem to be considering a response. There's also no relationship with real world goods and services that might anchor faith in the currency. For UST it has the LFG, but that seems to have been of limited help.
Was this always going to happen? Some have questioned whether the algorithmic peg made sense at all. Joe Weisenthal dug out a part of his interview with Sam Bankman-Fried who said that, "they can serve some useful purposes, but if you do zoom out... and you say, this is a stablecoin, backed by volatile assets, what's going to happen in a big market move? Right? Like, you know how this plays out." Others also seemed to predict this outcome particularly astutely.
System? What system? Binance briefly suspended LUNA and UST withdrawals, citing a “a high volume of pending withdrawal transactions” caused by network congestion. It said it would reopen withdrawals once it deemed the “network to be stable and the volume of pending withdrawals has reduced." This kind of knock-on effect is not uncommon in the real world -- stock trading can be suspended, withdrawals suspended or limited -- but it always undermines confidence, and is part of the very system DeFi was attempting to displace.
Complexity Whatever triggered the run remains a source of debate (here's one version). It may also be a wake-up call to investors who may not have understood all the risks connected to what looked like a safe bet. Here, by way of illustration, is one explanation of why the peg won’t come back immediately, whatever the efforts to do so.
What are the implications? It has renewed calls for self-regulation, arguing that salvation lies within. In the short-term, the worry is over contagion: Blue-chip NFT collections like BAYC found themselves hit harder than Bitcoin (see below for more). A more philosophical discussion about DeFi's future can be found here and here.
(Stories/tweets by: Antonio García Martínez; Stacy-Marie Ishmael; Dinesh Kulkarni; Michael Koziarski; Joe Weisenthal; Ryan Weeks; My Life in Defi; FreddieRaynolds; Jesse Hamilton; Ryan Selkis; David Z. Morris; Block Enthusiast; valleyboy.eth)
[What's behind the broader fall in crypto?]
Bitcoin and other cryptocurrencies have fallen to levels not seen since July 2021 (an age in crypto terms.) What is behind it, beyond the Terra debacle above? First off, there’s been a fall in all asset classes, which may be small comfort for those who saw crypto as a hedge against inflation — and insurance against the performance of other assets, according to the FT. The Telegraph argues that the fall is in part because the drying up of easy money caused by the U.S.' quantitative easing has slashed trading volumes in DeFi — down 82% from its peak last September. What should we expect to happen? Mark Cuban sees the situation as similar to the dot.com “lull”, believing that the next driver will be when chains are able to offer smart contracts that don’t merely “copy what everyone else has”, but are used to “boost productivity and profitability.” And El Salvador’s president Nayib Bukele announced on Twitter: that he had “just bought the dip", buying 500 coins at an average USD price of $30,744 (see Tidbits below).
(Stories by Samantha Dunn; Lauren Almeida; Chris Nuttall)
[Are NFTs the missing glue between social and financial?]
Social networks and financial networks are still awkward bedfellows. If Web 2.0 was all about interactions, Web 3.0 is supposed to be about transactions. But the race is still on to find a way to link them smoothly, to be the first to build rails and reap the rewards of connecting the two worlds more seamlessly. Meta has been keen to do so, at first with its failed cryptocurrency, and more recently through the metaverse, but it’s now trying another tack: Non-Fungible Tokens, or NFTs on Instagram. Reaction has varied from cold to enthusiastic, but there are some who feel that this might be both the stimulus both NFTs and Meta need.
Starbucks also sees NFTs as a way to tighten the bond between customers and the brand, using them to create “a new model of what it means to be connected to the Starbucks community.” Not all employees were delighted by the plan.
There are other moves which suggest bridges are being built. Binance is among 18 investors backing Elon Musk’s $44 billion bid to purchase Twitter, which has made people wonder what it means for the social network’s future. Is this about crypto being integrated into social networks, where a Twitter wallet allows the user to maintain tokens, transact with NFTs, and analyse credible ratings on products and influencers based on activity? Or is this deeper: part of Musk’s vision to redistribute power on Twitter via a more decentralised social network?
(Stories/tweets by: Anushree Dave; Kate Irwin; Ben Strack)
[Tidbits]
El Salvador: salvation or distraction? The Financial Times's Ethan Wu points to an academic study (PDF) that purports to show minimal adoption of Bitcoin in the country. And El Salvador is expected to default as its bonds are now trading at 40% of their value, according to El País. This piece from Rest of World takes a more nuanced look, saying that the core of the problem of adoption is the government app, Chivo, but overall things don't look good for the experiment.
That was quick: Last week we mentioned in issue #17 interesting crypto adoption in Latin America, especially in Argentina. In short order, Argentina’s central bank, under IMF pressure, has banned its banks from offering crypto trading. But then again, where there's a will there's a way: China, which has banned nearly everything crypto-related, may not have stamped the activity out altogether. While it’s hard to measure how many people in China are trading crypto, nearly 10% of web traffic to OKX, which consistently sits atop the 15 exchanges worldwide, comes from China, according to web analytics company SimilarWeb," according to TechCrunch.
Insurance: As crypto adoption spreads beyond the hardcore crowd so too does the demand for traditional services like insurance. The likes of Allianz have expressed cautious interest. Which raises some questions: if traditional insurance players provide such services, does that undermine the Web 3.0 ideal of self-custody? Does the crypto landscape increasingly need to reflect the real-world (but with enhanced technology) to be accepted / become ‘normal’? Check out this piece: Question of centralization faces growing crypto insurance industry
[Reading]
China’s Move to a Central Bank Digital Currency - Conversable Economist
Greening the Crypto Revolution by Marion Laboure - Project Syndicate
The Web3 Movement’s Quest to Build a ‘Can’t Be Evil’ Internet | WIRED (declaration of interest: we were involved in ETHDenver and with Gilad on aspects of the story)
This newsletter is pulled together by a team led by Jeremy Wagstaff, formerly of the WSJ, BBC and Reuters and Samantha Yap, founder of YAP Global. Other members: Ruby Wu, Roslyn Tear and Becky Corbel. Many thanks to Joey Woo for production. Any views expressed here are not necessarily those of the writers, YAP Global or its clients.