What’s behind the latest crypto dip?
Every Thursday on Sceptic vs Optimist, we’ll look at crypto’s less pleasant characteristics. We’ll be speaking to people with years of crypto experience, and tackle tough questions, while honestly weighing the pros and cons of the crypto world. And it won’t be boring jargon.
If crypto is all it’s been hyped to be, then why is it dipping?
Aha. I thought you’d ask. Let me start by saying, the crypto market is less than a decade old, and there are bound to be periods when the market dips due to different factors. Call it teething if you like.
As you probably know, when there is confidence in the market, investors hoard cryptocurrencies like bitcoin, increasing their value. But, unfortunately, there is extreme fear among investors, which has led to many selling their crypto assets.
Even crypto whales (individuals and companies that hold large amounts of crypto) are selling their coins. This has caused the crypto market’s value to drop, resulting in the dip we’re experiencing.
The basic economics rules still apply here; when demand is low — in this case, because of fear — prices will fall.
Okay, so how do you explain stablecoins not being stable? Why are they falling too?
This is not entirely true. Stablecoins, in theory, are supposed to be stable since they are usually backed by real assets, i.e. the US dollar, gold, silver etc. But, here’s where things get very interesting: there are four types of stablecoins (Physical, commodity, algorithmic and crypto-collateralised). Stay with me:
- Physically-backed stablecoins are the most popular, like USDT, USDC and BUSD. These types of stablecoins are backed by physical dollars — which means that for every USDT issued, there’s a corresponding dollar in a bank reserve.
- Commodity-backed stablecoins are tokens that are pegged to commodity products like silver, gold etc. A good example is Paxos Gold. If you hold 1 Paxos Gold, you own a physical gold kept in a vault.
- Crypto-collateralised stablecoins are unique tokens backed by cryptocurrencies. A good example is DAI, a stablecoin backed by Ethereum. These types of tokens are usually over collateralised — you have to deposit more cryptocurrencies to hold these types of tokens. For example, to buy $100 DAI, you need to lock $200 worth of Ether (ETH).
UST on the other hand, the stablecoin that became unstable earlier in the week, uses a different system that depends on algorithms — pieces of codes — to maintain its peg to the dollar. Hence it is referred to as an algorithmic stablecoin.
In the case of UST, it is controlled by an organisation called Terra. Terra aims to maintain a one-to-one value with the US dollar through an algorithm that controls the supply of UST and its sister token, called LUNA.
Okay, here’s how it’s supposed to work.
LUNA and UST are interchangeable, and each time UST is exchanged for LUNA, the UST is burned (or removed from circulation) and vice versa. The idea is for LUNA to exist as a token used to maintain UST peg to the dollar.
So investors are incentivised to continue this system in three ways.
- When UST is trading below $1, investors can buy and exchange it for $1 worth of Luna for profit.
- In contrast, if UST trades above $1 the investor exchanges their LUNA for UST for profit.
- They can also deposit their assets on Anchor, a lending platform that offers around 20% interest yearly on UST deposits.
This delicate balance of exchanging two tokens worked perfectly until last week.
So, what happened?
There was a weird development that resulted in many people selling vast amounts of LUNA and UST simultaneously.
This created pressure in the market, and UST’s price dipped from the stable $1 to around 97 cents. To make things worse, UST holders found that they could not exchange their assets for LUNA.
Then came the panic. UST holders did a massive sell off on May 10, and this led to UST dipping to $0.3. That was a 70% crash from a token that was supposed to be a stablecoin. Its sister token LUNA fared worse, dipping by more than 90%.
Thankfully, Terra was able to delegate over $1.5 billion worth of bitcoin from their reserves to back UST and this appears to have worked. UST is currently valued at $0.8, but we don’t know when it will return to $1.
The story of UST and LUNA is an excellent example that even perfect systems can falter and lead to heavy consequences.
What angle to this dip are many people not considering?
Many people overlook that despite the massive dip in the market, it still compares favourably to other popular stock options. For example, Bitcoin’s price has dipped by 47% in the last 12 months, which is significantly better than Netflix (65.18%) and Shopify’s (70%) stock prices.
Furthermore, Bitcoin is known to undergo massive pumps after huge dips. The dip is significant but overstated. Therefore I won’t be surprised if the price of Bitcoin pumps in the coming days.
Crypto optimism long-term: smart or foolish. Lol. You know my answer.
Smart, of course!
Crypto is the future of finance, and the adoption of popular coins like Bitcoin by countries (El Salvador and the Central African Republic) as well as institutions (Tesla, Microstrategy, Starbucks) is a testament to this fact.
We’re also early as less than 5% of the world’s population holds any form of crypto. Imagine how valuable the crypto market would be if 50% of the world adopted it in different forms. So there’s a lot of optimism about the future, and the current trajectory bodes well for crypto.
Since crypto is giving you heat right now, what gives you joy these days?
I resonate with the word YOLO (you only live once), and I’ve learnt to enjoy life. I’m also involved with some charity organisations that educate and empower young people. Reading books and hanging out with friends are other ways I enjoy myself.