‘More Systemic Risk’—The Stablecoin Fallout Could Be Just Starting As The Price Of Bitcoin, Ethereum, Terra’s Luna, Solana, Cardano, XRP Sink

The crypto market is covered in red again.

This week the price of bitcoin price fell 2.4% and ethereum’s price is down 5.0%. Cardano

ADA
fell 9.8%, XRP

XRP
lost 6.14%, and solana slumped 12.4%. Meanwhile, the price of BNB

BNB
rose 7.4%.

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The waters are still murky after the mid-month roiling of the crypto markets. Since the big dip, most cryptos have been crab walking sideways as investors wait for the murk to clear to see where the market might be headed this summer.

Some analysts are saying the worst is behind us. Others point to the interconnectedness of DeFi platforms and the brief depegging of tether—the world’s largest stablecoin—which suggests the fallout from the LUNA

LUNA
/UST

UST
debacle may not be over.

[Ed note: Investing in crypto is highly speculative and the market is largely unregulated. Anyone considering it should be prepared to lose their entire investment.]

Zooming out

Tether

USDT
wasn’t the only asset to feel the effects of UST’s downfall. CoinDesk writes about a “little-noticed effect of the terraUSD (UST) collapse.”

The report references a letter published Friday by Goldman Sachs that suggested the interconnection of DeFi platforms “amplify systemic risk.” It relates the story of Lido, a liquid staking protocol that got caught up in the web of DeFi.

To explain Lido it’s important to understand the concept of ETH 2.0 staking derivatives. ETH

ETH
2.0 staking began last December with the launch of the proof-of-stake Beacon Chain. To become a validator on the Beacon Chain, candidates need to stake at least 32 ETH (currently worth about $63,000). Eventually, the main net will migrate to proof-of-stake from its current proof-of-work consensus mechanism. However, until then all assets staked in ETH 2.0 are locked up.

In order to create some liquidity from these assets, Lido has developed special derivative tokens that represent staked ETH and that can be used to earn a yield on otherwise locked-up assets. (Investors receive a staked ether token (stETH) at a ratio of 1:1.)

The story might have ended there. However, holders were able to convert their stETH tokens into another token called bonded ether (bETH). bETH could then be staked on Terra’s Anchor Protocol.

According to Goldman Sachs, when UST collapsed and the Terra blockchain halted, this interconnection of DeFi platforms resulted in stETH trading at a 4.5% discount to ETH.

Looking Ahead

This is just one example of the many interweavings of DeFi protocols. Another is Deus Finance’s DEI coin dropping to 52 cents before reaching its current value of $0.75.

Will there be more examples of the risks of interconnected DeFi platforms in the future? Could instability in the stablecoins spread to broader financial markets?

The fear is real. Morgan Stanley

MS
recently reported that its clients have been expressing concern that the depegging of UST and other stablecoins might pose a “more systematic risk for broader financial markets.”

However, in a note published on May 13, Citi said it does not expect broader economic fallout due to the fact that the digital-asset market is relatively small compared with traditional asset classes.

And according to Bank of America

BAC
, fears of a crypto winter are unfounded. They point out that UST was not backed by traditional assets, while the largest stablecoins by market cap were not subject to the same risks as algorithmic stablecoins and so maintained their value.

That said, Citi goes on to point out that the death of UST will stir up more regulatory scrutiny for stablecoins. Although it could fan the flames in the short term, many agree it’s a necessary “evil” to avoid these types of risks in the future.

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