May 13, 2022 - Economy

Stablecoin weakness has investors on alert for contagion

Data: CoinGecko; Chart: Axios Visuals

Following the collapse of the Terra stablecoin on Wednesday, selling pressure briefly forced the world's largest stablecoin — known as Tether — to fall below $1 early Thursday. It's the latest sign of pressure on the supposedly safe coins at the heart of the crypto economy.

Why it matters: While Tether reclaimed its $1 value, the disconnect has focused minds even more sharply on what seems like the growing fragility of the crypto markets in recent days.

  • Tether officials were able to calm what appeared to be the the equivalent of a bank run with public assurances that people can continue to easily redeem their holdings at the full $1 value.

Catch up fast: Earlier this week, TerraUSD (also known as UST), the world's fourth-largest stablecoin, suddenly collapsed from its dollar peg. And Luna, the cryptocurrency that was supposedly backstopping the coin — completely self-immolated, wiping out billions of paper wealth.

  • That the contagion then hit Tether — the world's largest stablecoin with a market cap of more than $80 billion — sent shockwaves through the world of crypto and, perhaps, beyond.
  • Around the same time Tether lost its tie to the U.S. dollar, prices for Bitcoin crashed sharply to $25,000 in overnight trading, though it also rebounded.

What we're watching: Whether the crypto contagion will make the jump out of the cryptoworld and into the reality-based financial system. There's a couple ways that could happen.

  • Tether works a bit like a money market mutual fund. It's coins are backed by collateral such as Treasuries and short-term corporate debt called commercial paper. If it's hit with waves of redemptions, it could be forced to sell off this collateral suddenly — roiling those markets.
  • A broad crypto collapse could expose financial ties to other non-crypto entities that have grown in recent years.

What they're saying: "Many regulated financial entities have have increased their exposure to cryptocurrencies, defi [decentralized finance] and other forms of digital finance in recent months," wrote analysts from Fitch Ratings. "There is also a risk of an impact on the real economy, for example through negative wealth effects if crypto asset values fall steeply."

The bottom line: In the world of finance, no one likes to admit something is a big problem, unless they absolutely must. But when price moves are massive, the truth comes out.

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