When Luna was valuable — it hit an all-time high of $119 last month — it could support UST. But once the UST slipped, speculators knew that arbitrageurs would buy it cheap in the market and trade it for Luna using the Terra Station protocol. Luna’s bid would explode and her price would crash.
Sure enough, on May 10, Luna’s market value dropped to less than half of UST’s capitalization, meaning there was no feasible way to redeem all UST coins at par, according to Amit. Chaudhary, head of decentralized finance research at Polygon and Ganesh Viswanath. -Natraj, professor of finance at Warwick Business School. From that moment, the ankle’s disappearance became a self-fulfilling prophecy.
Does this collapse imply that stablecoins can never be stable? Not really. This is probably a warning against learning the wrong lessons from the world’s most successful stablecoin, one that has weathered multiple crises without interruption: the Hong Kong dollar.
Pegged to the US dollar for nearly four decades, the Asian financial center’s currency is a stable, albeit paper-like, coin. Most of the time, it relies – just like the UST – on arbitrage to maintain its value at 7.8 to the dollar. But there are two key differences. The Hong Kong Monetary Authority operates a pure currency board. All of HKMA’s monetary base is 110% backed by US dollar assets. Second, while fixing the exchange rate, the authority deliberately lets interest rates float freely to absorb pressures on the parity. When the local currency is sold off, there is a flight of capital from Hong Kong. But this automatically raises interest rates enough to attract buyers.
Terra worked differently. For one thing, the UST stowage was “under-guaranteed”. The Luna Foundation Guard, the nonprofit that acts as the network’s treasury, said it held 80,394 bitcoins on May 7. This ammunition, worth nearly $3 billion, was almost entirely spent in just a few days. However, the rescue mission ultimately failed.
Moreover, the network did not leave interest rates to demand and supply: it attracted new capital even in normal times by offering a return of almost 20% on UST deposited in Anchor Protocol , the leading DeFi lending app on the blockchain.
Successful currency boards avoid playing with the price of silver. Hong Kong only cared about interest rates in rare circumstances, such as during the Asian financial crisis in August 1998. At the time, hedge funds raised HK$30 billion (HK$3.8 billion). dollars) in the debt market by exchanging their US dollars. They had also bet on the fall of Hong Kong stocks. Their goal was to dump their local currency hoard, triggering automatic sales of US dollars by the HKMA to suck up liquidity and stabilize the peg. The resulting spike in local interest rates would have crushed stocks, handing hedge funds a profit of HK$3.6 billion on a 1,000 point drop in the Hang Seng index in 100 days. (It was a HK$4 billion bet, and the cost of borrowing funds was HK$4 million per day.)
That’s when Hong Kong, rather controversially, put its reputation for laissez-faire on the line and dipped into its accumulated fiscal reserves to buy $15 billion worth of shares in the second half of the year. August, forcing speculators to leave with heavy losses. The city was more than prepared to live with high interest rates – a determination it showed during the prolonged period of high unemployment and deflation that lasted until the 20th anniversary of the currency peg. in 2003. But she didn’t want the logical economics of the peg exploited to cause a self-fulfilling financial crisis.
Maybe the Terra project got its priorities wrong. “If Bitcoin’s contribution to cryptocurrency was Ethereum’s immutability and expressiveness, our added value will be usability,” co-founder Do Kwon and others wrote in their April whitepaper. 2019. When it comes to people using a currency, governments have an intrinsic advantage over the private sector. As long as Hong Kong collects taxes in local dollars, there will be a demand for it. Trying to build business with a 20% return on deposits may have bought the user-friendliness of Luna and Terra, but at the cost of stability.
More from Bloomberg Opinion:
• Central banks can save DeFi. Really: Andy Mukherjee
• Exchanges Bloodies The Chainsaw Massacre of Crypto: Lionel Laurent
• TerraUSD woes concern all markets: Aaron Brown
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News.
More stories like this are available at bloomberg.com/opinion