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Stablecoin Credibility Takes a Hit with the Fall of UST Coin

The collapse of the UST coin is wreaking havoc on the crypto market and destroying industry efforts to win the trust of the general public.
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Bob Dylan once said that "there is nothing so stable as change" and after the last few days, stablecoin investors would probably agree.

Cryptocurrency prices were finally starting to climb on May 13 after taking a severe pounding for the last few days.

The market was severely rocked when the stablecoin UST and its sister coin Luna lost nearly all their value.

A Matter of Trust

UST and Luna are the main tokens of the Terra protocol, a decentralized and open-source public blockchain protocol for so-called algorithmic stablecoins, which are backed by a computer code instead of traditional collateral like cash.

The two cryptos took a massive blow when crypto exchanges Binance and OKX decided to delist them in order to protect their customers.

So does this mean the end of the line for stablecoins? Not necessarily, analysts say.

"When looking at stablecoins, it’s important to keep in mind that there are different types of them, and that some are more trustworthy than others," Frank Corva, senior analyst for crypto and blockchain with Finder. "Industry leaders like Vitalik Buterin, Ethereum’s founder, and Sam Bankman-Fried, CEO of crypto exchange, have warned about the dangers of algorithmic stablecoins like UST for weeks now."

Corva said that UST was primarily backed by its sister asset, Terra (Luna), which had to be burned or permanently destroyed. 

A stablecoin is a digital currency whose value is pegged to a fiat currency like the euro or the dollar. In other words, to take the example of the UST, 1 UST is therefore supposed to be equal to $1. The goal is to offer investors a way to buy cryptocurrencies that are supposed to be stable, unlike bitcoin or ether, since they are in fact dependent of the fiat currency to which they are pegged.

'Death Spiral'

"Theoretically, burning Luna would drive the price of the asset up, as the asset would become more scarce, and therefore more valuable, all while more and more UST was created," he said. "To further support UST’s peg to the dollar, Luna/UST’s founder, Do Kwon, also made it public that he had purchased $1.5 billion worth of bitcoin to collateralize UST in the event that the asset was attacked.

Corva said UST was attacked this week, "and UST’s design and the collateral that supported it weren’t enough to keep it alive."

The yet unknown attacker, or attackers bought and shorted a substantial amount of UST, he said, likely knowing that the Luna Foundation Guard, the organization that oversees LUNA and UST, would be forced to make every effort to maintain UST’s dollar peg.

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"Make every effort they did, which provided an opportunity for the attackers to long UST when its price was low and then short it again when the price got closer to a dollar," Corva said. "This created what’s colloquially termed a 'death spiral'. Creating such a scenario in traditional markets is highly illegal. In crypto - the Wild West of finance - you can get away with it, though."

This Could Happen to You

Corva warned that users of other algorithmic stablecoins such as Magic Internet Money (MIM) and Tron’s USDD should recognize that what just happened to UST could just as easily happen to these stablecoins.

Dmitry Mishunin, the founder and CEO of a DeFi security and analytics company HashEx, said the most reliable stablecoins are the fiat and centralized ones as they are issued by centralized entities.

"Each of them is governed by a fund which owns reserves of various assets and securities," he said. "The fund is regularly audited for its declared capital to be confirmed for conformity with the fund’s real composition, but many investors dislike the unnecessarily high centralization of such assets because the money in the account must be transparent, otherwise it may be blocked, and investors turn to algorithmic stablecoins backed with cryptocurrencies."

The main idea of algorithmic stablecoins, Mishunin said, "is to create huge profits for their owners."

"Many protocols are trying to launch their stablecoins backed by native assets, as this is an opportunity to make profit almost out of thin air,"  he said. 

Mishunin advised investors to "thoroughly study the mechanisms of backing of the stablecoins you store your assets in and think about diversification."

'Get Educated'

"I would recommend using a centralized USDT, USDC or BUSD to store your assets if you're sure your assets are 'clean', or a decentralized DAI if you have assets of ambiguous origin," he said.

Despite the carnage, Travis Bott, CEO of Meta Labs Agency, doesn't believe that all stablecoins are dead and writing them off would be akin to declaring electric cars unsafe because one model was recalled.

"I think in any market you’re going to see different approaches to technology, application of technology," he said, "and how those things can be unrolled into the marketplace and what we’ve seen clearly is that the algorithmic position that Luna took didn’t work."

Bott's advice is simple: get educated and make sure you understand the things you’re putting your money into and use sound investment principles that still apply in the crypto market.

"Don’t just go throw your money at shiny objects because it appears the price is going up," he said. "Make sure you’re using sound fundamental principles for due diligence and for investing."