Blockchain Insider - Diving deeper into Terra
Primer: Join the hosts Mauricio Magaldi and Simon Taylor in this summary of the podcast episode of Blockchain Insider, where they talked about the recent Terra/LUNA crash. They also discussed the broader stablecoins space in general and how we can all move forward from this incident.
Recap
Terra or UST, the most recent poster child for algorithmic stablecoins, crashed and burned, taking the market with it
Luna crashed under $0.001 and lost over 99.999% of its original value
Anchor protocol is offering a 20% yield on UST and this attracts a lot of consumers who want a higher savings yield
What are stablecoins?
1 to 1 equivalent of a fiat currency of choice
In the case of UST, it’s to the US dollar
3 types of stablecoins: centralised, crypto-backed and algorithmic
Centralised stablecoins
Have equivalent real-world assets like cash, bonds and other instruments.
It is tokenized money, where you have the real-world assets but the money gets issued on the blockchain
For it to work, there must be a belief that there is $1 sitting in a bank somewhere for every dollar of centralised stablecoin
Crypto-backed stablecoins
Similar to centralised stablecoins but have other cryptocurrencies backing them instead
Usually, for every dollar issued on the blockchain, they have more than an equivalent dollar in crypto backing that
For it to work, there must be a belief that there is $1.5 to $2 worth of Ethereum or Bitcoin sitting in a reserve somewhere for every dollar of crypto-backed stablecoin
Algorithmic stablecoins
Not backed by any assets
Have a bunch of rules between a couple of pairs of cryptocurrencies that operate in tandem
E.g. In the case of UST, LUNA can be burnt to mint UST and vice versa
For it to work, there must be supply and demand of UST and its sister token LUNA for the mint/burn mechanism to function properly
What happened with UST?
If nobody wants UST or LUNA, and sells it really fast, the whole system crashes
People are selling faster than the Luna Foundation Guard (LFG) can sell their reserves of Bitcoin
Even selling their Bitcoin at a discount cannot keep the peg of UST at that point
“So the problem with real-time liquidity is you get real-time bank runs, or real-time stablecoin runs.”
- Simon Taylor
People are worried about USDT too because they have these dollar equivalent in the bank but if someone wants to redeem their USDT, who are you going to sell that dollar equivalent and how long does it take to sell it?
This is unlike TradFi where there are settlement delays
This is a form of time arbitrage where people can take advantage of the differences in the speed of settlement of the same asset but in different places
“If one rail is super, super fast, and the other one takes days, there is a time arbitrage. And that, of course, is going to impact the price of the assets on both sides of the equation.”
- Mauricio Magaldi
The lesson is that if you tokenize something, you’re as good as the fiat version of it and you’re going to be limited by that in some ways
Is there a future in stablecoins?
Important to differentiate the types of stablecoins, with algorithmic stablecoins being the riskier types
Another important part of this is education
Retail investors being attracted by a 20% yield and not doing their own research is part of the problem
Regulators need to
Understand the differences between the types of stablecoins
Set up a proper framework for issuers of stablecoins to follow to prevent this from happening again
Regulations
Regulators and those in TradFi might not understand some of the nuances
“And maybe it was just early and not wrong, which is often the case in technology. Sometimes an idea is just way too early and not ready and somebody needed to have some kind of big breakthrough.”
- Simon Taylor
Perhaps someday, someone will crack the way to do algorithmic stablecoin
Christine Lagarde of the European Central Bank, as well as the IMF, mentioned something to the effect that stablecoins not backed by anything can be dangerous
There is a lot more education work needed to be done
G7 immediately came up with a statement urging swift and comprehensive regulation of crypto in general
Mauricio hopes that regulators will study this and read through everything and not make a hasty response
While the tech is early, there might be a need to address some form of individual repercussions for the people promoting these unsustainable schemes
Simon agrees because when you are dealing with financial services, the level of responsibility needs to be very high because we’re dealing with people’s ability to put a roof over their heads
Should not ban algorithmic stablecoins in general. Otherwise, a whole new innovation and research category will be cut off
Not cool to find Do Kwon at his house - need to be civil about this if we want this to be solved at an industry level
Some concerns about Tether and its ability to stay solvent in the medium to long term even though the audits show that they have plenty of backing to the stablecoin
MakerDAO with DAI is the interesting one because they have very transparent governance and anyone can go and read up and participate
One of the oldest DAOs around
No central character or cult leader associated with MakerDAO
The community is debating openly how to move forward and discussing thoroughly before voting
Not trying to move fast but trying to move right
Risks of a company coming to the crypto space
Risk in the governance
Risk of smart contracts, which are immutable once programmed
Risk of associating a regulated entity with crypto, which is not yet fully regulated
Despite the risk, it is important to explore the crypto space. If not, the services or products you offer to your clients will get less and less relevant
There is so much capital flowing from traditional markets to web3, and this includes many talented people
David Marcus, previous the guy behind Libra at Facebook (now Meta), started Lightspark which does Bitcoin payments
Many people who had historically done well in tech are doubling down right now
This is despite what happened to Luna/Terra
One just needs to be careful and thoughtful while grinding and learning about the space
Simon heard from his contacts that many big tech companies are starting to take crypto very seriously
Still very early
Wallets are a means to enter Web3 space and we’re just starting to scratch the surface of this
“And to be honest, I feel this is 1991 type filling where you're like primitive internet type stuff, because right now we're seeing the inner workings of this right, the wallet is the engineering bit, right?”
- Mauricio Magaldi
Web3 is not matured yet because we still see the engineering bits with all the hashes and 0x and Xs. When the technology disappears, then we’re there
In the book Crossing the Chasm, anyone who wants to play with a new thing is fundamentally different from somebody who needs a complete solution before they’ll use anything
Web3 is definitely in the early adopter space where 2.5% or less of the population has played with the space and used it
This is exciting and interesting, but it is not for everybody
Need to sort out some issues in the industry ourselves
How do big institutions buy into crypto assets because they will need some sort of institutional-grade software, which is not the same as what retailers do
How to deal with compliance, KYC, AML etc
How to prevent risk from occurring without even the regulator coming in
Simon loves to show people a demo
He will open up an application to show what web3 is, then proceed to show them analytics of how people are using the application
These data are not available in the web2 space e.g. Google, RobinHood, Facebook etc
Once people realized its power and potential of it, they will be very impressed
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