Terra crashed. What does it mean for other stablecoins? Here are the potential winners and losers

Though Terra’s backers said they are endorsing a community plan to rescue the stablecoin, it didn’t provide much comfort. In a sign of alarm, a forum dedicated to Terra-related discussions on Reddit included a post with international suicide-prevention hotlines that was pinned by the moderator.

Some crypto industry participants said it is a “dark day” for the whole sector, as one of the most popular blockchains to grow at a breakneck speed, saw the value of its coins nearly collapse.

Investors also are closely watching what Terra’s fall may mean for other stablecoins, which play an important role in the crypto ecosystem and account for about 13% of the crypto market’s capitalization.

A stablecoin is a type of cryptocurrency whose value is pegged to other assets, usually fiat currencies such as the U.S. dollar. They are designed to maintain a stable price, which makes them popular when it comes to facilitating trading, lending and borrowing of other digital assets.

Explained: What is an algorithmic stablecoin? Why is Terra in the news? Here’s what investors need to know.

For the past few days, most other major stablecoins, including Tether
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and USD Coin
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have seen steady prices. 

“The events transpiring over the last few days cannot be interpreted as an indictment of all stablecoins,” David Puth, CEO of Centre, which provides technology for USD Coin, or USDC, wrote to MarketWatch via email.

In fact, some traders think UST’s fall will boost demand for other stablecoins in the short term, as investors move funds from UST to its counterparts. “There’s around $10 billion if not more of capital from UST looking for safer stablecoins to park in,” Matt Maximo, research analyst at Grayscale wrote to MarketWatch in an email. 

Still, some investors are worried that the plummet of UST may stir up more regulatory scrutiny around stablecoins. At a hearing Tuesday before the Senate Banking Committee, Treasury Secretary Janet Yellen said that Terra’s crash “simply illustrates that this is a rapidly growing product and that there are risks to financial stability and we need a framework that’s appropriate.”

Yellen also said it is “highly appropriate” to draft legislation around stablecoins this year. 

Read: Algorithmic stablecoins may be ‘inherently unstable,’ Sen. Toomey says after Terra episode

In November, the Biden administration called on Congress to quickly pass new legislations that would require stablecoins to be issued by insured banks that are overseen by federal banking regulators.

“Of course, regulation in the long-term is net positive for the crypto space but if stablecoin issuers get regulated as strictly as banks, it could suffocate one of the most innovative, thriving, and important sectors of the crypto market,” Anto Paroian, chief operating officer at crypto hedge fund ARK36 wrote to MarketWatch in emailed comments. 

A representative of Luna Foundation Guard didn’t immediately respond to an email seeking comment. 

Winners, losers? 

UST’s fall also intensified the divergence of views on different kinds of stablecoins. Some supporters think it shows the merits of reserve-backed stablecoins, such as Tether, USD Coin, and Pax Dollar, as they could offer more protection for consumers. “There is a consistent store of value and far fewer counterparty risks when using a fully-collateralized stablecoin over an algorithmic instrument,” said Centre’s Puth.

Still, the largest stablecoin Tether has long been criticized for holding commercial paper, bonds, loans and other digital tokens in its reserve.

Tether’s holdings of commercial paper have been decreasing quarter over quarter, a spokesperson for the company wrote to MarketWatch. “Unlike these algorithmic stablecoins, Tether holds a strong, conservative, and liquid portfolio that consists of cash & cash equivalents,” the spokesperson wrote. “We do not believe that the UST situation means anything for the centralized stablecoin market. They are entirely different types of assets,” the spokesperson said.

Despite Terra’s plunge, some investors remain confident about DAI, another algorithmic stablecoin. Unlike Terra, MakerDAO, which backs DAI, requires 150% of collateral to mint DAI. 

“MakerDAO is better protected from the value of its crypto collateral dropping sharply overnight by having more collateral than circulating DAI,” Grayscale’s analysts wrote in a recent note. “The one caveat is that they are less efficient systems, so are harder to scale,” said Corey Miller, growth lead at decentralized crypto exchange dYdX.

Some stablecoins that operate similar to UST, however, have been under pressure.

The funding rate for the perpetual futures of TRX, a coin that backs algorithmic stablecoin USDD of the TRON blockchain, fell deep into negative territory on Binance. Meanwhile, USDD, which is supposed to trade one to one against U.S. dollars, fell to as low as 98 cents on crypto exchange Poloniex Wednesday.

Justin Sun, founder of TRON, said on Twitter that the community will use $2 billion to maintain the stablecoin’s price.