Crypto is weathering a bitter storm. Some still hold on for dear life.
One shiny premise of DeFi, or decentralized finance–a catch-all term for cryptocurrencies and blockchain projects related to the exchange of value–is that by spreading out and automating operations, and removing power from middlemen like banks, it can offer a system more resilient to global forces, able to survive events like war and economic downturns that pummel traditional markets. Some industry insiders even suggested that crypto could be a good investment bet to ride out a possible recession .
Now, in this precarious financial environment, where the traditional market is sliding rapidly and Big Tech stocks are plummeting, this theory of resilience is going through a real-life test. The results are not good.
Bitcoin has taken its own nosedive in the past few weeks, while Ethereum and others have dipped as well. “Web2” tech companies such as Amazon and Netflix are seeing their stock prices drop. Coinbase, one the top three crypto exchange platforms and Robinhood, which supports cryptocurrency trading, have seen theirs fall along with them. Even popular proof-of-stake network Solana has seen its coin drop in value by about 80% since its all-time high in November. The big crash was last week when TerraUSD (the major algorithmic stablecoin) plummeted dramatically. A $100 stake in UST last Monday was worth just $18 by Sunday morning; that much in its sister token, Luna, is worth pennies now.
Stablecoins, as the name suggests, are designed to be the rocks of the crypto ecosystem, pegged sturdily to real-world assets like the dollar. Stablecoins are used by exchanges to balance out volatility and crypto investors may prefer them as a safer way to store money. They have served their function pretty well so far, although questions around consumer safety and their potential for illicit activity have certainly caught the attention of regulators.
Algorithmic stablecoins, however, are different. They are a DeFi experiment and are not tied to fiat money. They don’t have collateral assets to stabilize their values. They are supported by a second token in a push me-pull-you math equation. Terra, for instance, compensates fluctuations in the stablecoin’s value by increasing/ decreasing the supply Luna tokens through incentives. Investors can profit from these exchanges which keeps them–in principle–trading tokens at the amount the algorithm predicts. This is magic thinking.
Well before the Terra crash, algorithmic stablecoins were generally understood to be much less stable than regular ones. Even Sam Bankman-Fried, CEO of the crypto exchange FTX and a notable “crypto billionaire,” argued on Twitter last week that the two types of stablecoins are so distinct from both a functional and risk perspective that “[r]eally, we shouldn’t use the same word for all these things.”
Why should we pursue algorithmic stablecoins? They were supposed to be the DeFi holy-grail: a stable unit that self-corrects elegantly and independently, much like water naturally finding its level. They appeal to Bitcoin purists because algorithmic stablecoins aim to avoid what regular stablecoins like Tether and USDC rely on to function: a tie to the real world and traditional markets. They work on code alone, and the system assumes that human traders will behave in a predictable manner. If algorithmic stablecoins can perform as expected, it could prove that code is the future in finance, giving new credibility to the crypto worldview.
For a while it seemed that Terra’s experiment might work. In February, Terra closed a multimillion-dollar sponsorship deal with the Washington Nationals. Just over two months ago, in March, its blockchain–the seventh most valuable in the world at the time–became the number two staked network, unseating Ethereum. Things went awry on Monday, May 9. Someone could have caused UST’s value drop by acting against the algorithm. The coin fell to $1, fueled by fear-driven “bank runs” and human error. When UST reached $0. 37 on Thursday, the company that manages it, Terraform Labs, even made the last-resort call to temporarily stop transactions on its network to protect against further decline and then froze them once more overnight–preventing any token holders from taking what little they had left and running. Terra’s UST has fluctuated well below $0. since the network was restarted. 50; Luna hovers just above zero. Each company in the crypto ecosystem has a different explanation for why it is faltering. Coinbase’s much-anticipated new NFT marketplace had an underwhelming launch at the end of April, which may have put off investors and hurt its stock price. The Luna Foundation Guard, the nonprofit that supports Terraform Labs, had stockpiled $3.5 billion in Bitcoin by early May and then seemed to sell off a chunk of its stash in order stay afloat as the price of UST began to dip; both actions could have helped contribute to drops in Bitcoin’s value. Some Terra/Luna supporters even accused BlackRock and Citadel of intentionally manipulating the market to force UST to crash–a rumor vicious enough to prompt the companies to respond, asserting that they had no hand in the event. Then there is the issue of management. CoinDesk reported that the CEO of Terraform Labs was also behind a previous failed algorithmic experiment; maybe his leadership was another hole in the stablecoin’s boat.
But all these faulty pieces add up to an experimental system that is vulnerable to the same market trends as traditional finance–only without strict regulation and strong guardrails. The price tag of last week’s wild ride tallied up to some $270 billion in crypto assets lost. Even the non-algorithmic powerhouse stablecoin Tether briefly ducked below its $1 peg last week, indicating that standard stablecoins may not be immune to volatility. The impact of all this activity likely extends beyond crypto’s borders.
With banks launching crypto products and non-algorithmic stablecoins relying on the paper dollar to keep them steady, the crypto industry is clearly “tethered” to the rest of the financial market in multiple ways; the question now is if the plummeting coins will drag down traditional stocks in return. In January, Paul Krugman predicted in the New York Times that crypto assets may be the new subprime mortgages–bad eggs that have the power to spoil the whole market. This week, individual crypto investors claimed to have lost their life savings already. There could be more pain.
But even as social media fills up with mocking memes and skeptical news outlets label this the start of a crypto “winter”–a term used when technologies undergo a prolonged period of public disinterest and lack of innovation–crypto executives and investors are not just betting the crypto ecosystem will return to its glory days. They are planning for it. Even the word “winter”, suggests there will be a spring for those who are patient.
On Wednesday, Terra founder Do Kwon tweeted a threaded letter to the Terra community, describing his plan to resuscitate the stablecoin and assuring that it would turn around. He wrote, “Short-term mistakes do not define what can be accomplished.” “It’s how you respond that matters.” Coinbase founder Brian Armstrong is also claiming a full-throttle focus on the future as the company’s stock tipped back up on Thursday after losing half its value. In an internal memo that Armstrong made public, he wrote, “Volatility is inevitable. We can’t control it but we do plan for that… I just know we will get through it.
Many crypto believers are ready to embark on this journey. The prevailing philosophy of Web3 enthusiasts is HODL: “Hold on for dear life.” That is both for the good of the crypto community and to preserve the value of one’s own holdings through a dip. Some Terra/Luna owners and Terra/Luna fans call themselves “Lunatics” but they are actually holding on tight. Do Kwon’s plan for Terra to be nursed back to health involves burning large quantities of Terra tokens, which is a significant loss for Terra and Luna owners. As of Sunday, more than 60% of governance token holders had cast in favor of the plan; it needs only 40% to pass, and the vote is set to end on Tuesday. The next trick is for executives and investors to convince the rest the world that crypto–Bitcoin in particular–is still a healthy experiment. They have good reason to believe that belief can drive up unbacked cryptocurrency markets . In a well-timed statement on Thursday, Bitcoin’s Lightning network startup Lightspark–founded by a veteran of Meta’s shuttered stablecoin project–announced that it had received funding from major Web3 players Andreessen Horowitz and Paradigm, among others. That same day, Bankman-Fried disclosed that he’d made a significant new investment in the faltering investment platform Robinhood; on Friday, the stock leaped 22%. This week may see more confidence- and stock-boosting announcements by crypto bigwigs.
It remains to be seen if the real money flowing into the industry from angel investors and VCs can keep it afloat through the icy times. If it does, how many of its acolytes and regular market investors will be lost to the freezing waters.
Rebecca Ackermann is a writer, designer, and artist based in San Francisco.
I’m a journalist who specializes in investigative reporting and writing. I have written for the New York Times and other publications.