Did Stablecoin’s Collapse Pose Broader Threat?

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The col­lapse of the Ter­raUSD sta­ble­coin didn’t just drain $45 bil­lion from investors fol­low­ing a run ear­li­er this month. It raised ques­tions about the sta­bil­i­ty of decen­tral­ized finance (DeFi) as a whole and its risks to the broad­er finan­cial markets.

Those ques­tions got two dif­fer­ent answers from two bank­ing giants last week, as Bank of Amer­i­ca ana­lysts called fears overblown. At the same time, Gold­man Sachs warned that it showed just how inter­con­nect­ed the DeFi ecosys­tem is.

See also: TerraUSD’s Price Col­lapse Shows Vul­ner­a­bil­i­ty of Dol­lar-Pegged Cryptos

The ques­tion of sys­temic risk is one that cen­tral bankers and reg­u­la­tors have spec­u­lat­ed about for some time: That it’s not so much the direct loss­es to investors of a cryp­to melt­down caused by the spec­tac­u­lar fail­ure of a cryp­tocur­ren­cy or a broad­er cryp­to win­ter of col­laps­ing prices.

More than a few tra­di­tion­al investors now own cryp­to. If they take a past­ing, they might have to sell oth­er invest­ments, poten­tial­ly at fire-sale prices. And a small-but-grow­ing num­ber of pub­lic com­pa­nies have expo­sure to cryp­to or the indus­try that serves it.

Bloomberg Opin­ion colum­nist Matt Levine com­pared the risk — or at least the argu­ment that there is one — to the sub­prime mort­gage cri­sis in 2008 when the val­ue of the finan­cial assets backed by these mort­gages collapsed.

Investors “had to sell oth­er stuff to pay off their debts, which drove down the prices of oth­er stuff, which led to broad mar­ket con­ta­gion, which destroyed a lot of wealth, which reduced eco­nom­ic activ­i­ty, etc.,” he wrote on May 12, as Ter­raUSD was col­laps­ing. “Mean­while, the banks had lost mon­ey and were more risk-averse and less able to lend, reduc­ing eco­nom­ic activ­i­ty. And so nor­mal peo­ple lost their jobs because of con­ta­gion from some weird finan­cial asset that they hadn’t even heard of.”

Was Ter­ra Dangerous?

Bank of Amer­i­ca ana­lysts said that both the risk of con­ta­gion with­in the cryp­tocur­ren­cy mar­ket and spillover into the tra­di­tion­al mar­ket were unfound­ed, Coin­Desk report­ed. For one thing, Ter­raUSD was an “algo­rith­mic sta­ble­coin,” mean­ing its dol­lar peg wasn’t sup­port­ed by a bas­ket of cur­ren­cy and oth­er assets like treasuries.

Read also: PYMNTS DeFi Series: What Is an Algo­rith­mic Sta­ble­coin? DAI and the Fiat-Free Dol­lar Peg

How­ev­er, the largest sta­ble­coins main­tained their pegs as Ter­raUSD sank, and while the broad­er cryp­to mar­ket declined, it was doing that large­ly for oth­er rea­sons, Bank of Amer­i­ca noted.

Gold­man ana­lysts came to a dif­fer­ent con­clu­sion after look­ing a lit­tle more close­ly at the impact of the col­lapse on the DeFi ecosys­tem, Coin­Desk said.

Lido is a DeFi stak­ing app that offers yield — inter­est — for lock­ing ether tokens into lend­ing plat­forms or the trad­ing pools that act as mar­ket mak­ers for DeFi-based cryp­tocur­ren­cy exchanges.

See more: PYMNTS DeFi Series: What is Yield Farm­ing and Liq­uid­i­ty Mining?

The con­nec­tion is com­plex, but the upshot is that Lido investors were award­ed a type of token that could, in turn, be locked into a Ter­raUSD-con­nect­ed stak­ing plat­form called Anchor.

The Lido-issued token dropped 4.5% as a result, part­ly because the col­lapse of the sta­ble­coin inter­fered with the abil­i­ty to with­draw funds from Anchor.

So what? Well, the token Lido issues — called stETH — is a “wrapped” ether (ETH) token exchange­able one-for-one with ETH. Which is to say, it’s a sta­ble­coin of sorts, although one is pegged to anoth­er cryp­tocur­ren­cy instead of a dol­lar. The 4.5% drop was essen­tial­ly a loss of peg.

The prob­lem is, Lido is huge, with about a third of all staked ether. That’s about $6.7 billion.

And it is an exam­ple of how “DeFi’s com­posta­bil­i­ty can the­o­ret­i­cal­ly increase sys­temic risk,” Goldman’s report said, accord­ing to CoinDesk.

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NEW PYMNTS DATA: THE TRUTH ABOUT BNPL AND STORE CARDS – APRIL 2022

About: Shop­pers who have store cards use them for 87% of all eli­gi­ble pur­chas­es — but this doesn’t mean retail­ers should boot buy now, pay lat­er (BNPL) options from check­out. The Truth About BNPL And Store Cards, a PYMNTS and Pay­Pal col­lab­o­ra­tion, sur­veys 2,161 con­sumers to find out why pro­vid­ing both BNPL and store cards are key to help­ing mer­chants max­i­mize conversion.

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