[The Straits Times] askST: Why did TerraUSD, Luna crash and what does it mean for crypto investors?


Crypto markets were shaken after the US Federal Reserve hiked interest rates on May 4 to curb inflation.PHOTO ILLUSTRATION: PEXELS


This article was first published on The Straits Times.


SINGAPORE - The cryptocurrency market plunged on Thursday (May 12) as panicked traders dumped their holdings, including the high-profile Bitcoin.


The world's largest cryptocurrency fell 12 per cent to US$27,000 to bring its losses to almost 60 per cent since hitting a peak of US$65,000 last November.


Markets continue to be volatile so any short-term recovery is unlikely with Bitcoin futures for July trading at around US$27,000, according to Asia Pacific Exchange, a regulated Singapore derivatives exchange that launched Bitcoin monthly futures contracts on May 5.


Bitcoin futures reveal the expectations of prices and are used by traders to protect their current positions from further downside.


Q: Why did crypto crash?


A: Crypto markets were shaken after the United States Federal Reserve hiked interest rates on May 4 to curb inflation. That sparked an outflow of funds from crypto.


Slowing global economic growth, the Russia-Ukraine conflict and the prospect of further interest rate hikes catalysed those outflows.


The market was also spooked when the stablecoin TerraUSD (UST) saw its peg to the US dollar shatter this week. Until it crashed, UST was the world's third-largest stablecoin. Its fall caused panic in an already pressured crypto market.


Q: How does the UST stablecoin work?


A: Stablecoins are cryptos designed to have a relatively stable price.


There are generally two types - algorithmic stablecoins and those backed by an underlying asset like gold or the US dollar, said Mr Feroze Medora, director of trading at crypto exchange GeminiApac.


UST is an algorithmic stablecoin and is dependent on the value of Bitcoin and Luna tokens, whichit maintains as its reserves.


"As an algorithmic stablecoin, UST is meant to be pegged to the US dollar. However, when Bitcoin and Luna prices fell precipitously, UST lost the peg," said Mr Medora.


UST slipped below its one-to-one peg to the US dollar on Tuesday and dropped to 20 US cents before recovering to around 50 US cents on Thursday, according to CoinMarketCap.


TerraForm Labs, the company behind UST, is incorporated in Singapore but did not submit an application for a licence under the Payment Services Act, The Straits Times understands.


It is also not a notified entity, which means it has not been granted a temporary exemption from holding a licence by the Monetary Authority of Singapore (MAS).


Q: How will the crash change the way regulators view the market?


A: MAS has consistently warned about the risk of trading in cryptocurrencies and bars crypto service providers from promoting their wares to the public.


"Cryptocurrencies are highly volatile and often not anchored on economic fundamentals. This means that it is highly risky and not suitable for retail investors," a spokesman for MAS told ST, adding that the authority is reviewing a regulatory approach towards stablecoins.


Mr Desmond Yong, chief strategy officer at the MAS-regulated crypto payment services company Digital Treasures Centre, said UST's crash will incentivise regulators to speed up their reviews of stablecoins.


"Regulators are also likely to place more focus on consumer protection and education on crypto for the retail investors in order to protect them from excessive exposure to the risk of crypto investing," he added.


Q: What should retail investors do?


A: Volatility is expected as part of an emerging asset class, said Mr Adrian Chng, founder of Fintonia, a regulated fund manager that runs a Bitcoin fund.


"Professional investors and market participants should look more critically at algorithmic stablecoins and other decentralised finance protocols and entities promising high yields without fundamental economics to support these promised yields," he noted.


Mr Heng Koon How, UOB's head of markets strategy, said "cryptocurrencies are still a relatively nascent asset with Bitcoin created only in 2009 and has yet to go through the rigours of various economic cycles".


Crypto experts believe investors should adopt a long-term view of the sector.


Mr Rudy Lim, chief executive of blockchain company OIO Singapore, urged investors to focus on the long-term practicality of blockchain technology. "If investors believe in this space, they might want to take advantage of this opportunity by building their positions with the help of experts."


Mr Medora said: "In the long run, investing in crypto allows retail investors to have a stake in the development of digital infrastructure that will serve as the foundation for the emerging digital finance space."

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