What Australian stablecoins can learn from the Terra collapse

What Australian stablecoins can learn from the Terra collapse

The Terra collapse was a first for the crypto world and what some feared was crypto’s ‘Lehman Brother’s moment’. Before its collapse TerraUSD (UST) appeared to be a lower-risk coin, known as a stablecoin, however, it collapsed and wiped out approximately $25 billion out of the crypto market.

As the name suggests, stablecoins shouldn’t experience the wild swings that the rest of the cryptocurrency world calls a Tuesday afternoon. The reason being, stablecoins maintain a 1:1 relationship with a particular currency, in this case it was the US Dollar.

When Terra lost its peg to the USD and its coins no longer represented real money, it caused a domino effect on other coins that used Terra to drop in value.

Similar shifts have happened in the past so the initial reaction from the company behind the stablecoin, Terraform Labs, was ‘We’ve seen this before and we know what to do.’ Only this time round the shift kept going which forced the company to introduce more of Terra’s sister token, Luna and then Bitcoin to stabilise the peg, which made matters worse and resulted in an eventual total collapse.

At the time of writing, each digital token that should have been worth USD 1 is now worth USD 0.02 and a stablecoin with a market capitalisation of around USD 18 billion is now worthless.

Given that every transaction on the blockchain is public record, it’s only a matter of time before we see exactly how much was lost by genuine investors and how much was gained by traders. Traders theoretically didn’t do anything illegal, but benefited from the algorithms and effectively contributed to at least some of those losses.

So, what can Australian stablecoin project developers learn from this episode?

Where TerraUSD failed: algorithmic stablecoins

Before May 10, the top three stablecoins by market capitalisation were USD Coin (USDC), Tether (USDT) and TerraUSD (UST).

Circle, the company behind USDC, maintains a verified reserve of USD 1 for each stablecoin token. For every USD coin in the world, there is one literal US Dollar in Circle’s reserves. This means investors can be assured if they needed to exchange their USDC, they would walk away with at least 1 US Dollar for each coin. Additionally, as a part of its commitment to openness and transparency, Circle releases monthly, independently verified reports about their US Dollar reserves.

While, UST works very differently – TerraUSD was an algorithmic stablecoin. Terraform Labs maintained UST’s 1:1 relationship with the US Dollar using a computer program that used UST’s sister cryptocurrency Luna. They alternately created and destroyed Luna tokens to maintain UST’s 1:1 peg with the US Dollar. Too much or too little of Luna pushes the peg and two weeks ago, through a series of events, that peg was pushed all the way to complete collapse.

The AUD Coin is coming

Not counting the numerous stealth or yet to be announced stablecoin projects, the most interesting new project from Australia is the recently announced AUD Coin taking the number of homegrown stablecoins to two. It’s safe to say this number will double by the end of the year.

And while everyone in the digital asset ecosystem would want to see all of these projects succeed, the first question is how can we make sure that Australian stablecoins end up more like USDC and less like UST?

Lesson 1: No algorithmic stablecoins

The cryptocurrency world hasn’t seen the end of algorithmic stablecoin – founders and investors will continue chasing the perfect algorithm to maximise their profits. However, after the Terra collapse, for investors to feel confident again, stablecoin project developers will need to ensure for every stablecoin that’s minted they keep an actual dollar in reserve. 

Lesson 2: Open and transparent holdings

Following on from Lesson 1, is the need for all Australian stablecoin projects to have transparent and third-party audited reserves, modelled like Circle. It’s not enough to simply declare the fact or make online promises. For the ecosystem to have complete confidence, the stablecoin projects will need to frequently have their reserves audited by third parties and have an entire section on their site devoted to these reports. Not only would that give their credibility an immense boost, it would also have a great Search Engine Optimisation (SEO) benefit.

Lesson 3: Be responsible

Amidst all the UST chaos, there was one very clear voice: Schadenfreude. Terraform Labs has a loud, trash-talking founder whose particular style of Twitter repartee might resonate with certain parts of Reddit and Musk fans but does nothing for confidence-building and corporate responsibility. Neither does creating a corporate entity in a manner that encourages evading legal responsibility.

It was only after much criticism that Terraform Labs agreed to explore restoring all of UST investors’ lost value. Terraform weren’t planning to restore funds because they didn’t believe that was the most important thing.

In my opinion, it’s a pretty big red flag if a stablecoin project points to lack of official stablecoin regulation for not being a responsible entity. Borrowing once again from Circle, Australian stablecoin projects should use this opportunity to demonstrate how self-regulation can and should work both for their investors and the ecosystem.

Lesson 4: The stablecoin is the product

For the Terra ecosystem, the stablecoin was just one product, it also had Luna, a cryptocurrency and it also counted Luna-based developers as their stakeholders. When the UST crumbled, the first thought was not how to reimburse those that lost funds, it was around how to help the developers whose projects suffered because of the collapse. The only way to avoid this outright conflict of interest is to ensure that the stablecoin is the focus of the project and not just another product.

Lesson 5: Promote cryptocurrency micro-investing not cryptocurrency trading

Since 2019, the price of Bitcoin has fluctuated between 20-40% and while these drops are dramatic, they should only matter to traders and not long-term investors. Those that invested small amounts of money – starting with as little as $5 a week – would have seen their portfolios grow over 200% in the same period of time.

Promoting micro-investing rather than trading helps reduce risk while allowing investors to explore new projects, including stablecoins, the exact principle that Chillur, a platform for beginner crypto investors, was built on. Users know that it’s not a ‘get rich quick’ scheme, they’re not worried by fluctuations or crashes, but instead know to hold their nerve and play the long game.

Stablecoins are poised to become increasingly popular because they offer the opportunity to generate high, stable yields without the fluctuation of cryptocurrencies. For Australian investors, stablecoins might offer a simple path to explore digital asset investing and it’s up to the stablecoin projects to make sure that that path is as smooth as possible.