By Aaron Brown
The US financial markets and top regulators have focused on the fight in recent days by the stablecoin algorithm TerraUSD to return to its “locked” exchange rate against the dollar ($ 1 Terra = $ 1) after the cryptocurrency fell below 70 cents on Monday. Investors should be interested in the case, not in what it signals for cryptocurrencies, but in what it means for liquidity across the market spectrum.
Most of the cryptocurrency concerns are about the prices (in US dollars) of crypto assets. This is like trying to understand the US economy by looking only at the value of the dollar in the foreign exchange market. There is an extensive crypto-economy backed by hundreds of billions of dollars in development efforts that provide end-users with services on a daily basis. Its success depends on the value of these services and the new services that will be introduced to current and future users.
If for you the cryptocurrency is an unexplored continent, then you should know that cryptocurrency exchanges with traditional currencies are like foreign exchange markets. Highly liquid foreign exchange markets can boost a country’s gross domestic product, facilitating international trade and investment. But they can also cause problems.
Foreign exchange values are determined less by the underlying supply and demand of trade flows or the purchasing power parity and more by investor views and financial flows. Currency volatility and volatile investment flows can disrupt real economies. For this reason, most governments and central banks make complex efforts to manage foreign exchange and foreign trade.
Interface
Although the crypto-economy holds tremendous promise at a fundamental level, efforts to create stable financial transactions with high liquidity between traditional and cryptocurrency assets have been… not exactly successful. Some “crypto-lovers” believe that this is good, preferring to keep the cryptocurrency isolated from the regulatory framework and the problems of the traditional financial system. Other cryptocurrency lovers, however, look forward to linking traditional and “cryptographic” assets.
If TerraUSD collapses, it will not necessarily mean something of the fundamental value of crypto services, but it will be a blow to hopes that these services can be incorporated into the same financial system used for commodities and traditional financial services. Maybe in the future people who want services in the field of “crypto economy” will have to earn crypto to buy them and investors who want to participate in the profits of crypto industry consortia will have to spend those profits only in the field of cryptocurrency.
More importantly, if TerraUSD goes bankrupt, it will be a blow to the hopes of many traditional liquidity-based financial institutions to maintain stability. This universe includes central banks, stock exchanges (ETFs), funds, clearinghouses, securities traders and many other market participants.
TerraUSD is an “algorithmic fixed currency”, which means that it tries to maintain a $ 1 purchase price through an algorithm instead of traditional methods, such as supporting each token with a real dollar. TerraUSD can be exchanged for another $ 1 cryptocurrency, in this case Luna. Therefore, if the TerraUSD price deviates from $ 1, the arbitragers will have to force it to return to the exchange rate.
The Federal Reserve, although it does not have an official, statutory goal of a specific level of value for the dollar, can use a similar strategy if it wants to influence the value of the currency. If the dollar falls either in terms of purchasing power or exchange rates, the Fed’s two main monetary policy responses are to raise interest rates to make the dollar more attractive to hold or to sell assets for absorb dollars, reducing supply and thus pushing up the price of the currency. TerraUSD mainly uses the second strategy, selling Luna to reduce the TerraUSD offering.
The strategy is based on having a highly liquid market for the asset being sold – mainly US government bonds for the Fed and Luna for TerraUSD. Unfortunately for the Fed, if the value of the dollar falls, investors may not be excited about buying bonds, which are denominated in future dollars and whose perceived credit value may be reduced if they have to sell too much to absorb. the surplus currency. TerraUSD has the same problem, as the value of Luna is linked to the success of the Terra product line, which would be degraded by the collapse of TerraUSD.
Worry
ETFs face similar problems. Their price is intended to reflect the value of their underlying assets. If the ETF price deviates from the net asset value, the arbitragers are supposed to restore it by exchanging ETFs for their assets or vice versa. However, if either the ETFs themselves or their underlying assets lose liquidity, the ETF values may be decoupled from the underlying assets.
Clearinghouses are also based on day-to-day liquidity and limited price movements in their contracts. The London Stock Exchange discovered the risks of this situation in March, particularly in the futures contract for nickel.
The mechanism used by TerraUSD is not central to cryptocurrency. Many crypto entities experiment with it, but all for exchange purposes, but not for the production of fundamental services consumed by non-financial users.
The traditional financial system, on the other hand, depends heavily on liquidity-stabilizing mechanisms that are not as well designed or automated as TerraUSD. A collapse of the latter should logically cause you more concern about the dollar, ETFs and the traditional financial system than about the wider crypto space.
Source: Bloomberg
I’m Ava Paul, an experienced news website author with a special focus on the entertainment section. Over the past five years, I have worked in various positions of media and communication at World Stock Market. My experience has given me extensive knowledge in writing, editing, researching and reporting on stories related to the entertainment industry.
