The pressure on the cryptocurrency market continues to yield further turmoil, with news of crypto hedge fund Three Arrows Capital’s liquidation and suggestions of cryptocurrency exchanges in significant financial trouble as bitcoin and other cryptocurrencies continue to plummet in value. This turmoil makes for interesting speculation about the future of crypto-asset transactions. There are however key observations to be made about the technological operation of crypto-assets. This applies particularly where the operation of stablecoins are concerned, as they continue to become normalised for mainstream use:
- Stablecoins are not yet stable. Despite recent efforts by the US and UK governments to normalise stablecoin use for mainstream transactions, algorithmic stablecoins are not equivalents in stability to trading in fiat currencies. Other stablecoin mechanisms may prove more reliable in the future. Fiat-collateralised coins for example, use third party custodians to hold fiat currency collateral to assure a stablecoin’s value. However, these coins still rely on custodians keeping good audit practices (which is not always guaranteed).
- Shared ecosystems share risk. The stablecoin at the heart of current events, UST, was pegged to the value of another crypto-coin Luna, the centrepiece of the Terra blockchain. Prior to the crash it had a market cap of over $40bn. Luna however, functions like other crypto-coins: its participation and value is ultimately linked to the promise of its value increasing, as opposed to UST being designed to maintain a consistent value of $1. When the Luna sell-off occurred, the algorithmic mechanism that maintained UST’s value was unable to keep up with the rush of people withdrawing cash – and prompted a collapse of the entire Terra ecosystem (arguably along with the entire crypto-coin market).
- Is the crypto-coin ecosystem too small to avoid largescale market manipulation? There is some speculation that the collapse of both UST and Luna occurred as a result of an engineered process: a co-ordinated effort to force Luna’s operator to sell its Bitcoin reserve for the benefit of those betting against Bitcoin’s value. The interconnectivity and interdependency of these assets cannot be ignored, particularly while this is still a largely unregulated and ungoverned space.
- “Line goes up”. The hype-based volatility that preceded the current crash would likely be a characteristic of any speculative financial product. Crypto-assets (like Tulips and Dot-Coms before them) have been marketed for close to a decade as a speculative asset that will generate wealth for early adopters. Less observed is that blockchain technology can be an accelerant to this. Crypto-assets primarily accumulate value through the process of distribution, whether through selling coins or tokens to others or mining new ones. Unlike other assets, this accumulation is more directly intertwined in the technological workflow, arguably perpetuating dependency on the constant accumulation of that value. The line must always go up, and for that to happen, new participants are required to believe that it will.
The instability caused by this perpetuation could remain a barrier to the mainstreaming of crypto-assets for some time. An eventual resolution would be to refocus blockchain technology to narrower use cases, as a decentralised mechanism for governing trustless relationships. For now, the speculative volatility is self-evident from current events and demonstrates the need for caution.
Mitigations for the risks outlined above are a developing area. Ultimately however, stability will likely be a struggle to achieve for some time, particularly in an ecosystem where uniform best-practices are open questions, let alone more specific regulation. As current events continue to unfold, it will be crucial to observe how regulatory authorities and participants will chose to respond.