Stable by name, turbulent by nature
25 May 2022
In an unparalleled cryptocurrency collapse, the fall of the Terra ecosystem in May 2022 has resulted in over USD$35 billion dollars disappearing from the digital economy. Although a stablecoin by name, Terra USD has seen to be anything but, serving as a warning to all as to the turbulent and volatile nature of the market. Organisations that have suffered potentially irreparable losses as a result of the collapse of the Terra ecosystem may wish to consider overall financial posture and liquidity, as these losses may impact their capacity to meet customer demand in accessing or withdrawing funds.
Although the issue of digital assets as property has not been considered by an Australian court, the High Courts of both the United Kingdom and New Zealand have deemed cryptocurrencies as intangible, personal property, clearly an identifiable thing of value. As a result and unbeknownst to most retail investors, in the event of an insolvency of an organisation operating within the digital asset and cryptocurrency economy, cryptocurrencies held by the business may be considered property of that organisation. Therefore any customer of that organisation holding cryptocurrency would be treated as general unsecured creditors.
As the name suggests, a stablecoin is a type of cryptocurrency that seeks to maintain a stable value, and in most cases maintain parity to the US Dollar, such that one stablecoin token would represent USD$1. There are two main types of stablecoins, and how they achieve this parity varies based on the type of stablecoin being represented:
Asset-backed stablecoins such as USD Coin (USDC) and Tether (USDT) are effectively banks, holding large amounts of cash, commercial paper, liquid assets and other investments in reserve to maintain a stable price. In theory, consumers can turn in these stablecoins to redeem the underlying reference assets. It should be noted that some unlisted entities issuing stable coins do not fully disclose the credit quality (credit rating) worthiness of the underlying assets held. Consequently, in some cases an element of counterparty credit risk also needs to be considered.
Algorithmic stablecoins attempt to do the same thing but without any reserves behind them (thereby increasing capital efficiency), maintaining a stable price using algorithms and game theory to incentivize the market to self-regulate the stablecoin’s price. Algorithmic stablecoins have been criticized as effectively operating as unregistered managed investment schemes, requiring continuous inflows of cash to maintain parity and to prevent a collapse. Terra’s UST is one example of an algorithmic stablecoin.
Stablecoins are an important part of the digital asset and cryptocurrency ecosystem, often being referred to as a “hedge” against the volatility of the broader market, in addition to enabling peer-to-peer lending and borrowing, removing need for any intermediary or third-party involvement.
With many comparing the fall of the Terra ecosystem to that of the spectacular collapse of the Lehman Brothers in 2008, the size of the Terra market capitalisation may not be large enough to cause a broader economic crash, with the contagion likely limited to selling pressure and negative market sentiment within the digital asset and cryptocurrency ecosystem for now. However, it is expected that impacts within the traditional financial markets are likely to be felt within technology companies and riskier assets more broadly, as consumer confidence continues to fall from the highs of 2021.
McGrathNicol are experts in business restructuring, forensic accounting and cyber security. We have specialist cryptocurrency and digital asset tracing capability supported by world-leading technology. For more information, please contact one of our team.