23 December 2022

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The crisis starts from trust, be it banking or crypto

Luigi Campopiano

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Investors have had a dramatic time after the total collapse in the value of their investment, but what happened? Terra Luna, ranked among the 10 most valuable cryptocurrencies, saw the value of each token go from around $85 to practically zero.

Two causes are attributed to this collapse:

1. Some claim that what could be very similar to a Ponzi scheme has occurred since Terra guaranteed a return of up to 20%.
   
   
2. Some accuse Blackrock and Citadel — among the two largest investment funds in the world — of having sunk the project to hit the system and make money by first borrowing 100,000 bitcoin from Gemini and then using $25.00 to buy Earth by asking their founder if they could have a discount, given the large amount. The offer was accepted, however, thus reducing the amount of land in circulation. Immediately afterward, Blackrock and Citadel sold the other 75,000 bitcoin to bring down the price and unleashed a domino effect (than bought them back to return them to Gemini at a price that dropped to 26,000 euros, generating over one billion euros in profit in one day).

What happened can be compared to the famous bank runs when savers no longer trust their bank. 

The system was based on a value with a volatile guarantee like bitcoin. The fuse that struck this ecosystem was lit when some large withdrawals from Anchor Protocol took place: the institution had been fundamental in support of the stablecoin in recent months, which had gained popularity due to its annual rate of return of 20% offered to Terra holders to deposit tokens on the platform, in a manner identical to the functioning of a normal bank account to which interest is paid on deposits.

Their withdrawal caused deposits to drop from 14 to 11 billion. Subsequently, a withdrawal of 150 million was also made by the founders of Terra, pouring 100 million when the price started to fall. Still, by then, it was too late because its value had dropped from the dollar, initially reaching 65 cents. 

The collapse caused a violent shock wave on the algorithm's balance mechanism. When the price of bitcoin also fell beyond a certain threshold, the value of the shares collapsed, sending 40 billion of capitalization up in smoke, triggering a domino effect by losing the ability to maintain exchange parity amid the general disbelief of traders. 

This is because Terra is an algorithmic stablecoin with a value pegged at $1 and has gained the favor of operators for its known stability, even in critical market moments. This is the colossal failure that has ever occurred in the crypto markets (for now) by casting a shadow on the validity of cryptocurrencies.

The stablecoin is a currency that reflects the value of the fiat currency (legal tender: the money we normally spend. In Europe, the euro, in the U.S., the dollar, etc.) to which it is pegged, maintaining a constant ratio of one to one. 

It is the digital transposition, a cryptocurrency that maintains a one-to-one relationship with the current currency that the creators have chosen to make it stable. This stability is achieved either by holding liquid assets such as coins, shares and bonds with a high credit rating in an amount expressed in traditional currency equivalent to the coins in circulation or through algorithms that automatically manage sales and purchases to regulate the value of the digital currency. It is algorithmic when not based on a central depository or third-party intermediary, such as a bank, but on a neutral algorithm that stabilizes its price. Crypto traders also believe stablecoins to be a safe parking spot for their cash as they wager on the volatile cryptocurrency market.

The difference between stablecoins and cryptocurrencies:

• Stablecoins are a type of cryptocurrency created to maintain a less volatile price. The value of stablecoins is made stable by being pegged to a more stable element of exchange: a fiat currency (such as the dollar or euro) or a commodity (such as gold).
• Cryptocurrencies are very unstable in their valuation.

The substantial difference, therefore, is volatility, which makes the use of cryptocurrencies for daily payments difficult. The basic idea of stablecoins is to eliminate, at least in part, the volatility that has always characterized classic cryptocurrencies. Stablecoins are sometimes referred to as anti-bitcoins: this is incorrect because both allow payments with the blockchain system.

In conclusion, the solution could be:

• Don't invest in something you don't understand. It is important to know what you are investing in and, above all, the risks, such as the opportunities, that you are facing.
• When investing in potentially risky or volatile securities, invest no more than you can afford to lose. There is no easy money in finance; there is always a price to pay.
• Diversifying is the ideal solution when deciding to invest, whatever the product. One cannot escape a method, patience and a clear objective to obtain returns.