A plunge in cryptocurrency values and the collapse of popular tokens are stoking panic among some investors and boosting pressure on Washington to act.
Rising interest rates and recession risks have caused sharp selloffs across financial markets, including the stock market. Many crypto investors have seen their holdings evaporate — along with major players in the burgeoning digital asset space.
The value of one bitcoin has plunged 12 percent this week alone to roughly $29,700, its lowest level since July 2021 and just half the all-time high of $64,440 set in November. Ethereum, another popular cryptocurrency, is down 24 percent this week alone and nearly 50 percent on the year as well.
“Two main factors are at play: one is that the US Federal Reserve and other central banks are raising interest rates and removing liquidity and therefore removing key props to valuations across all asset classes – including crypto,” wrote Lil Read, senior analyst at GlobalData, in a Friday analysis.
“The second is that in a rising interest rate environment, investors generally become more risk-averse,” she continued. “The very lack of a tangible value anchor for cryptocurrencies can, at times such as now, make them appear extremely high risk – contrary to the original concept that attracted many original investors.”
Bitcoin, Ethereum and other major tokens have whipsawed in value for years and are expected to bounce back, if to a much lower ceiling. But their steep recent declines have sent shockwaves through the broader crypto market, knocking out the Terra network entirely.
The Terra network ran two cryptocurrencies: Luna, a digital token traded and exchanged like bitcoin; and UST, a “stablecoin” meant to be always equivalent to $1. While some stablecoin issuers use reserves of cash or other safe investment assets to back up the value of their tokens, UST was pegged to the dollar through a Terra algorithm that would either create or burn Luna depending on its performance.
One UST was designed to always be equal to $1 even if Luna plunged. But as Luna lost nearly all of its value — roughly $100 per coin — Terra’s algorithm was unable to burn enough of the currency to prop up the value of UST. The squeeze left both worthless, wiping out a network at one point worth $2.7 billion.
“The holders of Luna have so severely been liquidated and diluted that we will lack the ecosystem to build back up from the ashes,” wrote Do Kwon, founder of the Terra network, in a Friday proposal to move forward without UST.
‘While a decentralized economy does need decentralized money, UST has lost too much trust with its users to play the role,” he continued. “It is a hard balance – and no easy answers in redistributing value within the network. But value must be distributed to allow the ecosystem to survive, and in its current state it will not.”
The collapse of the Terra network has been devastating for investors who held either Luna or UST, particularly for those who expected a so-called stablecoin to live up to its billing. Luna and UST holders on online forums have shared heartwrenching stories of losing their life savings amid the collapse, prompting others to share links to suicide hotlines and other resources with despondent investors.
“When the integrity of the system overall is questioned and not reliable, people will walk away. There’s a reason why deposit insurance is important: It prevents runs on the bank,” said Tyler Gellasch, executive director of the Healthy Markets Association, a financial markets research non-profit.
“What we’re really seeing in the crypto community is a really powerful, real-time proof of why securities laws and banking laws exist,” he continued. “We’re recreating the very same messes — using new technologies — that bedeviled our great-grandparents and our grandparents.”
Though Terra investors have suffered deep losses, the damage is unlikely to upend the broader financial system given its limited connections to non-crypto assets and traditional financial firms. But Gellasch said a similar sell-off of stablecoin backed with other financial assets could trigger broader dysfunction in financial markets.
Crypto skeptics and advocates for tougher financial rules say the Terra episode should be a catalyst for Washington to finally update and expand regulations for stablecoins.
Cryptocurrencies and the platforms used to exchange and hold them often straddle the gaps between different rules and regulators at both the federal and state level. Lawmakers in both parties generally agree on the need for adjusting current financial regulations to better fit the unique ways crypto blurs traditional lines between securities, commodities and currencies.
“We really need a regulatory framework to guard against the risks,” Treasury Secretary Janet Yellen said before a House panel Thursday. “We need a comprehensive framework so that there are no gaps in the regulation.”
The Treasury Department and a Biden administration working group in November proposed a much tougher regulatory regime for stablecoins, arguing they should only be issued by financial firms backed up by federal deposit insurance. That would limit stablecoin issuance only to businesses subject to strict bank regulations meant to guard against future financial crises.
The Biden administration proposal, however, evoked fierce opposition from Republican lawmakers and many cryptocurrency industry advocacy groups, arguing it would wipe out entire swaths of the sector.
Sen. Pat Toomey (R-Pa.), the top Republican on the Senate Banking Committee, said on a conference call with reporters Thursday that incidents like the Terra collapse are a natural part of churn in a developing space. He has introduced legislation to create a federal stablecoin license to firms willing to follow specific disclosure rules and safeguards.
“Failure should be an option,” Toomey said. “It’ll probably take some failures in this space in order for the market to figure out what works.”