Panic in the crypto market has Washington regulators' attention

ByJulia Horowitz, CNN Business, CNNWire
Friday, May 13, 2022
One Inglewood business woman sets out to teach her community everything there is to know about cryptocurrency.
One Inglewood business woman sets out to teach her community everything there is to know about cryptocurrency.

WASHINGTON -- Investors in stocks, bonds and commodities are all on edge right now. But in the market for cryptocurrencies, unease has morphed into full-on panic, catching the attention of regulators in Washington tasked with maintaining financial stability.

What's happening: As of last Friday, the price of bitcoin had plunged almost 50% from its all-time high as traders - concerned about whether the Federal Reserve's bid to fight inflation could tip the economy into a recession - dumped riskier investments.

But in recent days, the implosion of TerraUSD, a high-profile crypto experiment, has fueled a deeper anxiety. On Thursday, Tether - a popular "stablecoin" billed as a safe place for crypto investors to park their cash - broke its peg to the US dollar, unleashing further alarm. The price of bitcoin fell as low as $26,350.

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"If we see this continue for multiple days, then we'll start to get pretty concerned, pretty worried," Marcus Sotiriou, a crypto analyst at digital asset broker GlobalBlock, told me. "The implications are just so large. It's just unknown."

Breaking it down: Making sense of the situation requires a quick primer on stablecoins and their wilder offshoot, algorithmic stablecoins.

Traditional stablecoins like Tether have become the bedrock of the crypto market, since they're theoretically fully backed by hard assets. One digital coin can be redeemed at any point in time for $1, serving as a hedge against volatility. Given the market's notorious swings, their use among crypto companies, exchanges and traders has shot up.

The Federal Reserve estimates that the value of stablecoins "grew rapidly over the past year," topping $180 billion in March.

The boom helped spur the rise of algorithmic stablecoins like TerraUSD. These coins are technically worth $1, too. But they aren't backed by hard assets, and instead use financial engineering to maintain their peg.

The entire sub-industry has worried experts, including the Fed. In a report published earlier this month, the central bank said there's little clarity on what really backs stablecoins, and noted that a few big players dominate a market with little oversight. A loss of confidence, then, could trigger a devastating run, which could in turn tank confidence in the entire digital economy.

It's not clear that's what's happening now. But as stablecoins churn, that is the risk.

TerraUSD first wavered and broke its peg to the US dollar last weekend. It fell as low as 23 cents on Wednesday before recovering some ground. It was last trading at 58 cents after its creators announced an emergency intervention.

"This is exactly the 'death spiral' a lot of people predicted," Henry Elder, head of decentralized finance at Wave Financial, a digital asset manager, told me.

Tether was last below 99 cents to the dollar, dragging down bitcoin, too. The most popular cryptocurrency - which has buy-in from a growing number of traditional investors - has plummeted 10% in the past 24 hours.

Why it matters: This may seem very in the weeds. Crypto assets, after all, continue to make up a very small part of the broader financial system. But powerful people like Treasury Secretary Janet Yellen are paying attention, fearful that the situation could create nasty and unpredictable aftershocks for investors of all stripes.

"A stablecoin known as TerraUSD experienced a run and had declined in value," Yellen said when she testified before the Senate earlier this week. "I think that simply illustrates that this is a rapidly growing product and that there are risks to financial stability."

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