How can a stablecoin collapse?

A clear case of playing on people’s sentiments.
How can a stablecoin collapse?

One of the biggest news from the crypto markets this week is the fall of stablecoins, many of which broke below their $1 pegs. It all began on May 9, 2022, after TerraUSD (UST), one of the most popular stablecoin, failed to maintain its value relative to the US dollar.

But how can a stable coin de-stabilize? A stablecoin is a type of crypto whose value is pegged to other assets, which in several cases is a fiat currency such as the US dollar. As their name suggests, these stable coins are designed to maintain a stable price.

While some stablecoins, such as Tether (USDT), are backed on a one-to-one basis by US dollars that are held in reserve, others, such as UST, attempt to maintain their pegs through algorithms.

The non-stable crypto LUNA acts as UST’s reserve currency. Essentially, Terra maintains its peg by minting and burning LUNA.

When UST is worth more than $1, LUNA tokens are burned or pulled out of circulation, so more units of UST can enter circulation, and its price drops. Conversely, when UST’s value dips below $1, units are taken out of circulation in order to purchase LUNA, pushing up the price of UST.

In other words, the stability of UST depends a great deal on the stability of LUNA.

How it happened


As UST started trading slightly below its dollar peg, people started cashing out their USTs for other stablecoins. This forced the algorithm to mint more LUNA. The vastly increased supply, in a largely bearish market, added selling pressure on LUNA tokens, and with the algorithmic continuing to mint even more LUNA, the coin plummeted from highs of over $100 to mere cents.

This fall also took down the price of UST. To make matters worse, US Treasury Secretary Janet Yellen called for stringent regulation around stablecoins right around the time when UST fell below its $1 peg.

Do Kwon, the founder of Terraform Labs, the organization behind UST, and LUNA acknowledged that the reason behind the significant impact on LUNA’s price was because of the algorithmic nature of UST.

Kwon is reportedly looking to raise over $1 billion from investment firms and market makers. While the deal isn’t finalized yet, many in the crypto community are echoing concerns that the UST saga could have broader implications across the market.

Although how this will play out is anybody’s guess, not everybody’s lost hope.

“Even fully-collateralized fiat stablecoins have de-pegged. Even some of the weak algorithmic stablecoins have recovered,” tweeted Emin Gün Sirer founder of Ava Labs which develops the Avalanche platform and AVAX cryptocurrency. Sirer added that de-pegging of UST has played out exactly as previous de-peggings, and if anything he’s now even “more bullish on UST once the dust settles down.”

The stories on our website are intended for informational purposes only. Those with finance, investment, tax or legal content are not to be taken as financial advice or recommendation. Refer to our full disclaimer policy here.