How the collapse of Terra's UST will impact the future of stablecoins | Interview

If you create an algorithmic stablecoin and you don't expect speculative attacks. Welcome to the real world.

Last week, the collapse of TerraUSD sent the crypto markets into turmoil. Panicking investors were even pulling out from Tether, the largest stablecoin, which briefly lost its one to one peg to the dollar.

So USDC and Binance USD, those are regarded as safe and Tether actually isn't regarded as safe in quite the same way.

Has Terra's downfall compromised investors trust in StableCo? And what are the systemic risks that this incident has exposed in the crypto ecosystem? To answer these questions, we Talked to Mike McGlone, senior commodity strategist at Bloomberg, and financial commentator Francis Coppola. But before we start, as always, don't forget to smash the like button and subscribe to our channel. I'm Giovanni, your host and this is a cointelegraph interview. So what do you make of the turmoil that we witnessed last week? Mike, do you want to go first?

Yes, thanks for having me, Giovanni, particularly Francis. I find with Francis I learn a lot. We have actually sometimes I think more in common than we disagree on. And one thing that's notable here is this is part of the ebbing tide of risk assets. And as some famous investor has said before, when the tide goes out, you see he's wearing clothes. We found out algorithmic stable coins that are based on a market that needs to go up wasn't the best idea. And even Sam Bankman Fried said this a little while ago. So it's very unfortunate what happened to TerraUSD. The bottom line is what this is what we've been expecting and hoping for to get past this year. So you need to purge the excesses of 20 and 21 in cryptos. I mean the Shiba Inu's, the Dogecoins, the 19,000 of them are just kind of ridiculous. And then get back to really building the foundation. What's happening with the transformation of technology and markets through crypto. So you mentioned that Tether. I like to mention Tether because it is the world's, excuse me, most widely traded crypto, typically based on coinmarketcap.com volume, it's double that of Bitcoin and spend that way for at least a year now. Now it broke, it's not really a peg. It broke around below the buck a little bit and came right back. And I just like to point out that lessons I've learned in Tether is the market doesn't care. This is a lesson I first learned in 2018 when I was in Hong Kong, it was around $2 billion. And then most notably in 2019, in April, when the New York Attorney General came down hard on tether initially broke down for a little while while bitcoin was around 5,000 and the market said we don't care, this is a better way to transact dollars. It's supposedly backed by physical assets that we can Francis can dig into and that this gave me great indications in the past for, for markets going higher. So back then it was when bitcoin was around 5,000 and now we've reached around 30,000. So I look at parallels now. Is this little dip towards 30,000 in Bitcoin is related to some of the speculative access is being purged. I suspect it's going to have similar support as is, but just not forget that. Also what happened this week was last week was The S&P 500 and Bitcoin both returned to the 100 week moving averages. So that's the key thing to remember. Everything is going down. It just cryptos went up the most. So they have to mean, they have the greatest mean reversion risks.

So now I would like to know what Francis thinks about those events because I know that Francis has a more skeptical stance towards stablecoin in general.

Okay, there are two things here. One is the general moving markets which Mike's highlighted, which I broadly agree with that actually everything is going down and crypto is just another risk asset class. So it's going to go down as well along with everything else. And that's all connected to the Fed raising rates and the generally kind of gloomy and worrying outlook for the economy and all sorts of things like that. I don't find that unusual. But then what happened? Terra and Luna is slightly different. I like your allusion to when the tide goes out, you find out who's swimming naked because that seems incredibly, incredibly appropriate metaphor for Luna really. But actually what happened there is a deliberate speculative attack to break the peg. And we've seen those before in algorithmic stablecoins before as well. They were after the bitcoin that Terra had collateralized USD with part collateralization. That's what they were after and they succeeded. And I don't think that there's really any realistic way that Terra and Luna can recover from this. But that doesn't mean that the rest of the crypto market is is going down. If I just talk briefly about Tether, because one thing I noticed was when you look at reserved stablecoins there's very definitely two different kinds There's Tether, which is trading more like a risk asset in many ways. So when everything was selling off in this panic we had over the last few days, Tether was selling off too. And when everything went started to go up again, then Tether went back up to its peg. But there were a couple of Stablecoins that went in the opposite direction. So USDC and Binance USD, both of which are fully reserved with traditional safe assets, that's where everybody was going was a complete flight to safety and those are regarded as safe. And Tether actually isn't regarded as safe in quite the same way. That's my take on it.

Frances made a good point when she said that when Terra collapsed and Tether lost its peg to the US dollar, we saw that investors moved their assets to Tether's competitors, USDC and Binance USD. So Mike, what do you think? Are these competitors going to take over Tether anytime soon according to you?

Sure. Well, I like to point out there is Tether and then there's a dozen wannabes. Just like Bitcoin. There's a bitcoin, then there's 19,000 wannabes.

There's.

That's the key point of the space. I like the point is Tether might be surpassed by some of the other stable coins that have better backing and things. But that's what's the bottom line here is the forest. The forest is the proliferation of digital assets, tokenization, crypto dollars via tokens. And they're just finding better ways to do it every day. And I look at it as that's an unstoppable trend and as I view as like the proliferation of Bitcoin and Ethereum, they're unstoppable trends. We're dipping in that trend. The key point is Tether has so many competitors and wannabes. That's indicative of where the space is going. So when you look at regulation in the U.S. i say sure, they're gonna regulate crypto dollars. I don't call them stablecoins, regulate it properly and then we don't have to worry. The world's. We look at China and trying to do a central bank digital currency. It's already happened organically and the world's gone for the dollar through these tokens. They just need proper regulation.

So even though Tether lost its peg to the US dollar, we also saw that it recovered quite quickly. And we also saw that it had to handle a large amount of redemptions in a very short time. It had to redeem around $3 billion worth of USDT and it kind of managed quite well. So that was a quite good stress test for Tether, don't you think, Francis?

Well, I'm not surprised. I mean the thing is that the redemptions that were tested were by exchanges. They were ftx, they were Alameda, they were Justin's son, they were big whales and exchanges. They weren't just ordinary USDT holders. Nothing has changed there. The big players have always been able to redeem. It's the small players who can't redeem. They've got to rely on exchanging tethers on exchanges and exchanges can shut the doors. Binance did yesterday that we are still where we have always been with Tether, which is when there's any kind of problem with tether, they simply close the doors for a while and provide some more liquidity and then it comes back up again. So in a way I kind of agree with Mike that I've been saying this for a while now, that the market, particularly offshore market, actually doesn't care whether there's actually any real reserves, safe assets behind Tether because they're not nobody actually holding it for any period of time. They're using it for liquidity and to facilitate trading. And in that respect it's, it's actually fulfilling a slightly different purpose, a different function in the market from the safe stable coins like usdc, which increasingly used as collateral. For borrowing and therefore in a way do need to be safe from a lot of USDC gets locked up in the dye vaults. That doesn't tend to happen to Tether. So I think they're slightly different things.

So even though Tether passed quite well this stress test, every time that something like that happened, there is a lot of rumors, a lot of fad around the possibility that a crisis like the one that Terra experienced could happen to Tether as well. So what do you think, Mike? Is Tether shielded from situations like the one we saw with Terra?

Oh yeah, well, it's not a peg. It's backed by physical assets supposedly. Now that was part of what happened with the New York Attorney General. They had to submit to a quarterly audit. Yes, it's dicey. I mean, I let the accountants dig into it, I'm a former accountant might realize that. But the point is, and even what Francis said is it doesn't matter so much that money is moving to the other stable coins that are clearly have very well backed by physical dollar for dollar assets. They're probably earning little interest and making pretty good money versus not paying anything on the coin. And the Point is, it's the macro infrastructure that's changing. Now. You mentioned stress test. This was a good stress test that people the space needed. Algorithmic stablecoins that are based on the bottom line, Bitcoin or whatever is related to going up. They're not a good idea. But it's just one of those things that, I mean, I'm learning the trading fit. Sometimes you look at guys doing things like, really? Okay, well, good luck with that one. But I'm sorry, but this is the thing that Sam Bankman Fried pointed out a couple weeks ago and how he said it with the interview on Bloomberg Little. I can't really repeat it, but to me it's the bottom line in the infrastructure big picture. That's when you see it hit the tape. You see Janet Yellen testifying in front of Congress. You realize how much in the mainstream this is now. And I like to hearken back to interviews last year with Visa and MasterCard where they both pointed out we're using stablecoins. And what they're using is more specifically up to them, probably usdc, but it's just a better way to transact. I mean, just think of a typical visa trying to SC Square up their dollar transaction on a gold basis. If they're lucky with banks, they get four days a week because of how they say anything. We're stable. With crypto dollars, you're 24 7. Instant settlement, poof, it's done. It's just where the world's going that way. And to me, it's just. And this is one of those things I remember with the Internet flush in 2000-2001, it was just a great time to buy Amazon and sell pets.com. you just have to filter out. To me, this is what's happening.

All right, and what do you think Francis is? Is tether shielded from possible crisis situations like the one Terra experienced?

Nothing's ever fully shielded from anything. Anything can lose money. But I don't regard tether as the disastrous run risk that I think some people want to see it as. I know that it's maybe not fully backed, that it's. Whatever assets it's backing it are not fully disclosed in the rest of it. But it's the way it's used. It's used really as a tokenized fiat currency. That's what it is. And fiat currencies aren't backed. People still use them. That's what it is. Pure, pure fiat currency. And as long as you recognize that that's all it is, then you do start to wonder why we've got this emphasis on it's got to have full reserve backing or there'll be a run on it. I'm wondering how anybody could run on it. They'll just shut the doors. There are clauses in the legal agreement actually making it possible for anybody, small holders to redeem it. I mean they have things in place to stop a run. And anyway most people buy their buy and use their sell and use their tethers on exchanges. You want to look at this pinch point, the risk points in the crypto space. I don't think it's stablecoin issue at all except the algos, some of the algos which are ridiculous because their Argos self stabilizing mechanisms don't work. But of the main stablecoins I don't think any of them are a serious risk. I think we should be looking at exchanges.

So what do you exactly mean when you say that we should look at exchanges?

Well, because that's the interface between the users of crypto and stablecoins and their issuers is actually the exchanges. They are the middlemen. They fulfill in that respect the same function as banks and they act a lot like banks. And so the stability risk, if you want to look at a stability risk in the crypto space generally, I would say is exchanges more than stablecoins.

And so can you describe a concrete situation where exchanges pose a threat to crypto's financial stability?

Well, here's a thought for you. It actually came up this week talking about Coinbase, that Coinbase somebody went trawling through Coinbase's legal documentation and discovered that although Coinbase offers custody, it talks about custody and offers custody products, they don't appear to be bankruptcy remote. So in the event of Coinbase failure, a lot of people are going to potentially going to lose a lot of money. And that would trigger a market panic in the crypto space. It would cause kind of a Lehman moment, if you like, in the crypto space. I think that's what we should be worrying about more than what's going on with stablecoins.

So now final question. I would like to know your thoughts about the future of algorithmic stablecoins. We saw that algorithmic stablecoins like Terra were providing a solution, an alternative to centralized stablecoins like Tether and USDC because they didn't have to rely on a centralized entity to hold some sort of reserves like a bank. Still after this massive collapse of Terra, now people would likely not trust anymore this mechanism. So do you think that the accident with Terra put an end to the experiment of algorithmic stablecoins for now, at.

Least in the short term. But they'll come up with a better way. It's like Francis said, when there's an attack like that, they'll figure out a way to get past attacks like we do with everything and new technology and fraud and everything. But it might, I'll end it there because I don't understand technology so much. I think it's better for Francis to comment on that. My point is this just shows the value of trading dollars cryptographically through tokens and some of the weaknesses in some of the algorithmic ones.

Okay, so Francis, what do you think? Do algorithmic stablecoins still have a future?

Obviously I don't think this is the end of the algorithmic stablecoin experiment by any means. I think that they will carry on trying to find ways of making foolproof, waterproof algorithmic stablecoins where the game theory always works and they, and they never get into the kind of negative feed, look, feedback loop that means the whole thing can collapse and there's no pot, there's no attack surface. It's a bit like a quest for fool's gold to be honest. For the philosopher's stone, to be honest. I'm not sure they're ever going to quite get there, but I've no doubt they will get closer over time and maybe close enough for algos to have some utility going forward. But I think they're probably always going to need some kind of fail safe and there will always be occasional collapses because it is really trying to like trying to set up a perpetual motion machine and I'm sure everybody knows that those things actually don't exist in the end. You're really trying to nudge people, create incentives for people to do this, that and the other, and trying to second guess what the market will do and what arbitrageurs will do. And every paper I've seen has always kind of missed the kind of the far out edge cases where in some states of the world arbitrageurs are not going to do what you want them to do. And so they can improve their game theory, they can improve their risk assessment, but I think there will still always be some states of the world that they won't have thought of.

Awesome. Thanks guys. It was a pleasure to have you on our show.

Pleasure, thank you.

That was Mike McGlone, senior commodity strategist at Bloomberg Intelligence and Francis Coppola, economist and financial commentator. I'm Giovanni, your host see you next time.