A “Stablecoin” Melts Down — What’s Going On And Why It Matters…
It’s been an interesting few weeks in the cryptocurrency world…
Earlier this month, we saw TerraUSD (also known as “UST”) — the third-largest “stablecoin” used by crypto investors, whose value is supposed to be pegged to $1 — fall below that $1 threshold.
It currently trades for around $0.02…
This sparked a major selloff in nearly all cryptocurrencies, including bitcoin and ether.
You might be wondering why these stablecoins even matter. Who would invest in them? And why is this affecting the rest of the cryptocurrency universe?
I’ll attempt to explain…
A Stablecoin Melts Down — And Why It Matters…
A stablecoin is a digital currency that is pegged to a more “stable” asset, like like the U.S. dollar. The general idea is that stablecoins should help reduce volatility, providing an easy mechanism to exchange unpegged cryptocurrencies like Bitcoin for a stablecoin, which should always be pegged with the dollar, for example, at 1:1.
Stablecoins are also crucial for DeFi (or decentralized finance) projects, allowing users to borrow and loan out their cryptocurrency.
So for starters, most people aren’t investing in stablecoins as an “investment.” In this way, you can think of them much like a money-market fund.
You see, money market funds are intended to offer investors high liquidity with a very low level of risk. The same goes with stablecoins… theoretically, they provide liquidity without as many fees.
But money market funds are still an investment and carry no guarantee of principal. If a money market fund falls below $1, it is called “breaking the buck.” It doesn’t bode well for investors. It will also have ripple effects across the entire financial system, as investors would get nervous and skittish and begin selling stocks to “save” their capital.
Well, that’s essentially what happened when UST “broke the buck.” It created widespread panic across the cryptocurrency universe.
For context, UST relied on the Terra network. Terra is a blockchain, just like bitcoin and Ethereum. The network’s cryptocurrency is called luna.
As this CNET article explains: “To create UST, you need to burn luna. So for instance, in early May you could trade one luna token for 85 UST (since luna was worth $85), but the luna would be destroyed (“burned”) in the process. This deflationary protocol was meant to ensure luna’s long-term growth. As more people buy into UST, more luna would be burned, making the remaining luna supply more valuable.”
As a result of the UST collapse, luna also cratered. This sent shockwaves through the cryptocurrency world.
Eye On The Prize
The price of ether, one of my top cryptocurrency picks, for example, went from around $2,190 on May 11 to $1,700 overnight. It has recovered some of those losses as it trades at around $1,971 currently.
However, if you have been following along with my cryptocurrency coverage recently, then I want to encourage you to keep your eye on the prize.
There is still a lot to like about the basics of the Ethereum network, for example, especially as we inch closer to the “Merge,” which is the largest blockchain upgrade in history.
I wrote about the Ethereum network and why I like it in this piece. In it, I mentioned something I called “Ethereum 2.0,” and that it is inching closer. This has now been dubbed the “Merge,” but in short, this is where Ethereum will revamp its entire infrastructure, moving from its current proof-of-work model to what’s known as proof of stake.
Under its current proof-of-work model, miners must complete complex puzzles to validate transactions, known as “mining.” This process requires a huge amount of computer power and is often criticized due to its environmental impact.
Once the merge happens, mining will become obsolete. As a result, it is predicted that Ethereum’s energy consumption will be cut by 99%.
Under the proof-of-stake model that will become the norm after the merge, users will be able to validate transactions according to how many coins they contribute, or stake. In return for staking more coins, users have a higher likelihood of being chosen to validate transactions on the network and earn a reward.
As the merge draws closer (there isn’t a set date yet), it’s important to note the effect it will have on Ethereum’s supply.
Because users will be staking coins for validation under the proof-of-stake model, there will be a limit on how many validators can withdraw their tokens once the merge is complete. This will prevent a drastic change in available supply and keep the network secure.
The supply of Ether is expected to decline post-merge because fewer coins are expected to be issued. If demand increases as the supply declines, the price of Ether will likely surge.
Much like most of the market, it’s been a tough and wild year for cryptocurrencies. But if you’ve dabbled in cryptocurrencies, here is the lesson you need to learn, if you haven’t already…
At this point, cryptocurrencies are speculations and should be treated as such. That doesn’t mean that I don’t think there will be some useful things that will come out of the crypto world, as I’ve explained before. It’s just that this wild volatility should be expected.
This is why I’ve also said don’t stake your next mortgage payment on these instruments.
If you don’t like volatility, then cryptocurrencies probably aren’t for you. But Ether and Bitcoin both remain “buys” for risk-tolerant investors.
P.S. I just released another BIG prediction about cryptocurrencies…
My team and I think cryptocurrencies will surge again in the coming months. But here’s the thing… the big winner won’t be Bitcoin, Binance, or Ethereum. While those cryptocurrencies could do well, we think there’s another one with a lot more upside potential for new investors. It’s 321 times faster than its prime competitor and could surpass it in value…
Learn more about our “shocking” investment predictions for 2022 right here.