The future of the Defi Sector Post the Terra Crash
The crypto market has been bearish since the November peak in 2021 when the market broke all previous records to attain a $3 trillion market cap and most of the top cryptocurrencies reached all-time highs. 2021, in short, was nothing less than spectacular and in contrast, 2022 is witnessing a mass slaughter with cryptocurrencies shedding their gains in response to multiple macroeconomic factors that were first triggered by the Russia-Ukraine war, followed by the Fed’s interest rate hike to curb the 40-year high inflation rates and the approaching shadow of a probable global recession.
But not all is black and white for the crypto market, as the current market conditions have revealed many not-so-robust projects and shortcomings in the overall Defi sector. The slew of insolvency events, hacks, and flaws became conspicuous post the singular event that shook the crypto market and Defi in particular — The Terra-UST crash. The Defi projects associated with the Terra UST platform witnessed an 80% decline post the crash.
Terra’s Untimely Demise and the Ensuing Crypto Market Death Spiral
What exactly happened? TerraUSD (UST), a popular stablecoin, lost its peg to the US Dollar within a few days after the investors panicked and tried to pull out their money from the project in May. This de-pegging caused many investors associated with the project to go bankrupt taking the entire crypto market into freefall. Around $400 billion in market cap was wiped off in the next few days. Experts cited the time as ‘among the most painful weeks in crypto history & one we’ll reckon with for a long time to come.”
“The way these algorithmic stablecoins are designed, they have this upward force during bull markets, which is how they get so popular. But the same forces act in reverse during bear markets and expose their fundamental flaws. So that is eventually what triggered [the crash].”
~Sam MacPherson, an engineer at MakerDAO
The crypto market cap stumbled below the $1 trillion mark for the first time since December 2020, and top cryptocurrencies entered deep correction losing 70–90% of their ATH values. The market hasn’t been able to revive, as such, and continues to be adversely impacted by the cascading impact Terra’s crash had. Any kind of project having any connection with the Defi ecosystem has suffered losses and many more continue to suffer ever since.
As of now, the UST token is worth 12 cents and LUNA has come down to a fraction of a penny from its April value of $116.
How Terra-UST Scandal Impacted Defi Prospects
Defi — the idea that got furbished around 2017 — soon caught the frenzy of the crypto masses, for the financial freedom it accorded against its traditional counterparts. Since then, it has attracted the attention of leaders, experts, and investors in the fintech space.
Defi has played its part in reshaping the financial space giving more control to individuals and making financial transactions more transparent, economical, instant, and without the involvement of legacy institutions. Defi has also eased lending and borrowing while streamlining the processes and providing a hedge against inflation and unforeseen market happenings. Stablecoins play a vital role in the Defi verse to allow investors and traders to move their funds to less risky assets in volatile markets. Added to that, investors and market participants can make use of the interoperability and liquidity Defi markets offer while making passive income on their holdings.
4-hour chart for LUNA, ANC, ASTRO, MARS, and USDT
Despite its umpteen advantages, the sector has suffered a huge setback due to the cascading impact of the Terra UST crash in May. Defi protocols like Anchor Protocol, Mars Protocol, and Astrport saw their prices fall by more than 80% in May. Similar scenes of bloodbath were seen in the Cosmos ecosystem in which tokens like Osmosis (OSMO), Mirror Protocol (MIR), Kava (KAVA), etc., faced steep corrections. The only silver lining was MakerDAO, which benefitted from the volatile conditions and registered a 124% growth on the day of the crash.
The ensuing impact of this debacle was that major lending firms such as Celsius and 3AC which had substantial investments in the LUNA ecosystem are hovering very near insolvency, withdrawals have been suspended in many protocols, and investors have lost their life savings in a matter of days. One investor wrote, “I’m going through some of the darkest, most severe mental pain of my life. It still doesn’t seem real that I lost $180,000.”
The death spiral took in the entire crypto market along with all major cryptocurrencies, worsening the bear market fever. BTC is barely managing to stay near the $20k mark while ETH is trading at less than one-fourth of its ATH value. The market looks no way near having reached its bottom and the uncertainity is driving away investors and institutional backing. The only respite is that the crypto sector will be shedding its wasted skin before it emerges with battle-tested projects and platforms and gets done with average or weaker projects.
Top crypto exchanges like Coinbase have slumped and the NFT trading volumes have plunged more than 50% ever since the crash. The cumulative effect of all this has set in the crypto winter, which may carry on for months before the resilient cryptocurrencies manage to stay alive as the market may witness a revival. When that would happen is a matter of uncertainty.
.“ I suspect some cryptocurrencies will be worthless and that capital investment in the space will slow to a crawl as investors nurse their losses, much as we saw in the Internet bubble.”
~ Edward Harrison from Bloomberg
The trust and repute the Defi sector had built in the past few years are shattered and it will take some great thought and efforts to tauten the weak links and tighten the regulations around cryptocurrencies and the Defi sector to serve the investor interest and market longevity.
While stablecoins have long been drawing the irksome eyes of the regulators, it is time for the Defi sector to be under scrutiny. The sector needs to self-impose some regulatory mechanisms before the regulators bring universal guidelines for the entire sector. Massachusetts representative Jake Auchincloss, while denying the need for a ban, suggested some measures that could prove pathbreaking for the Defi sector and its possible amalgamation with traditional finance. Auchincloss said that stablecoins could be brought under the purview of a federal bureau such as the Comptroller of the Currency. Stablecoins issuers should be required to maintain a liquidity reserve for 90 days and that they provide insurance for customers.
While private players could be given free rein on how to manage their risk-reward profile, governments are seeking to redeem themselves by imposing regulations to avoid any kind of systematic risks. Defi players, too need to rise above their usual game and look to secure and refurbish the weak links in the ecosystem that holds the potential to change the landscape of finance and credit globally.