Why Emerging Economies Are Reeling From the Terra Stablecoin Crash
Headlines over the past two months have placed cryptocurrencies in a state of reckoning, the initial impetus of which was the $45 billion Terra crash. Because Terra is a stablecoin, this type of currency is specifically coming under scrutiny.
A less-talked-about impact of the Terra crash was its role in emerging markets that struggle with volatile official currencies. For example: Argentina, whose national currency passed a 50% inflation rate this year.
In these environments, stablecoins ostensibly provide unique value to citizens as a savings mechanism and inflationary hedge. Many will purchase stablecoins not as an investment, but rather to store their earnings in a more “stable” currency. The Terra crash caused many employing this strategy to lose almost everything they had.
Stablecoin Typology: Algorithmic, Fiat-Backed, and Crypto-Backed Stablecoins
Before getting into the widespread impact of the Terra collapse, let’s first review why all so-called stablecoins are not created equal. Terra is an algorithmic stablecoin, which uses an algorithm to execute smart contracts that protect against market volatility in real-time. Terra uses a “two-coin” system to carry out this highly technical approach by tying its stablecoin to Luna, a governance token, to maintain its peg to the value of the U.S. dollar. One of the biggest appeals of algorithmic stablecoins is their true decentralization and sole reliance on their own code to transact (without need of a middleman).
Other stablecoin types include fiat-backed and crypto-backed stablecoins. Fiat-backed stablecoins are directly collateralized with fiat currencies, like the euro or dollar. Crypto-backed stablecoins are similar, but backed by other cryptocurrencies. These stablecoins must maintain an element of centralization in order to ensure a true asset backs each stablecoin 1:1, but in doing so, they are much more reliably “stable.”
One key takeaway from the Terra crash is the need to actively interrogate the collateral backing of each stablecoin in order to make more informed decisions. This explanation suggests a good collateral ratio for algorithmic stablecoins moving forward should be between 400% and 800%, which is much higher than current stablecoins typically hold. Unfortunately, this type of information tends to be difficult for the general public to access.
Hope Remains, Despite Massive Losses
Terra’s crash has had reverberating impacts across the world, and the worst was arguably felt among citizens in emerging markets, as mentioned above. Their losses may be smaller in overall dollar value, but the individual impact is very high.
Rest of World profiled Terra buyers in countries — including Argentina, Iran, and Nigeria — who lost upwards of tens of thousands of dollars as a result of the Terra crash. One director at an Argentinian crypto education company lamented, “Lots of people lost money they couldn’t lose…They don’t care if it’s an algorithmic stablecoin, a collateralized stablecoin, decentralized, or what — their attitude will be … ‘I lost all my money. I won’t come back.’”
Yet others, like one 19-year-old Argentinian trader who lost all his savings, took it as a lesson, saying, “I just need to be more careful how to invest my money.” And some consider even a highly volatile currency preferable to their national currency, with a consistently dropping value.
In Sub-Saharan Africa, the crypto ecosystem continues to grow, seemingly unfazed. Cameroon, the Democratic Republic of Congo (DRC), and the Republic of Congo have all announced separate partnerships with the TON Foundation to develop and adopt a new stablecoin in their country. In Asia, some investors are “backing away," though momentum has not completely slowed. Singapore in particular must manage the implications of serving as the geographic headquarters for Terra’s operations. Overall, while global gains in the crypto industry continue, the conversation has increasingly shifted to the need for regulation.
Regulation Is On the Way
A united approach to crypto regulation is long overdue. In the U.S., as in other countries including Japan, policy advancements have been moving quickly. In March of this year, President Biden signed an Executive Order committing to develop regulation and oversight of digital assets. Senators Cynthia Lummis and Kirsten Gillibrand have also drafted the Responsible Financial Innovation Act, which pushed the Biden Administration’s objectives forward by proposing specific next steps to build a regulatory framework for virtual currency and payment stablecoins.
Treasury Secretary Janet Yellen further backed up the need for regulation during a recent Senate Banking Committee hearing. Using relatively calm language, Yellen referenced the Terra crash, emphasizing, "I think [the Terra 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," she said.
Unfortunately, those who lost their life’s savings in the Terra crash are unlikely to recover it. Many will not care to distinguish the different types of stablecoins and will not have the luxury of taking another risk by trying again.
These headlines are enough to make even the most enthusiastic crypto supporter a little nervous. Yet, many are also unsurprised. This phase of volatility is nothing long-term crypto investors haven’t seen before. And there are also many notable positive developments. As is generally the case with the crypto market, only time will tell. And in the meantime, we can take comfort in knowing we’re a bit more educated on stablecoins, their impacts, and potential opportunity.
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