In recent weeks, prices for popular cryptocurrencies such as bitcoin and etherium have fallen, but stablecoins are also in the spotlight – and for all the wrong reasons.

TerraUSD, a well-known stablecoin, has broken the peg to the dollar and is now trading at near zero, leading to a wider collapse, and even cryptocurrency blue chips are suffering.

Bitcoin is trading at less than $ 30,000 compared to a peak of over $ 60,000, while Ethereum is trading at just over $ 2,000.

Market crash: popular stablecoin Tether experienced a short-lived crisis last week when its price fell below $ 1

A significant failure in TerraUSD, supported by algorithms rather than real assets, has prompted people to look more broadly at the future of stablecoins.

We look at what led to the collapse and what it means for stablecoins and the vast crypto market.

What are stablecoins and how do they work?

Stablecoin is a type of cryptocurrency that is pegged to real assets such as the US dollar.

They were developed in part in response to the volatility of other cryptocurrencies, such as bitcoin, whose value is constantly fluctuating, but now stablecoins are starting to fall.

They are based on blockchain technology, similar to cryptocurrencies, but created for greater stability.

There are stablecoins with crypto and precious metals, but the most common are usually stablecoins secured by fiats, which are backed by the state currency.

Then there are algorithmic stablecoins that are not backed by any asset. They use a computer algorithm so that the value does not fluctuate too much. He can issue more coins when its value increases, and redeem them in the market when the price falls again.

Traders typically buy stablecoins that are accepted on cryptocurrencies and then used to buy and sell other cryptocurrencies faster.

Tether is the largest stablecoin – it is pegged to each other with U.S. dollars, and he says it is fully backed by its asset reserves, which include U.S. government bonds, corporate debt and a small amount of cash.

Stablecoins have been developed in part in response to the volatility of other cryptocurrencies, such as bitcoin, but as the past week has shown, they are not risk-free.

Why did TerraUSD fail?

The difference between TerraUSD was that it was backed by an algorithm, not real US dollars.

The algorithm will adjust Terra USD’s supply through another token, Luna, to keep its value pegged to the dollar.

This stopped working when the value of the Moon fell to almost zero, adding pressure to the already turbulent time in the cryptocurrency market.

Traders say it was caused by a series of large withdrawals from Anchor Protocol, a platform created at Terraform Labs, the company behind the token.

These deals have prompted more and more investors to pull their TerraUSD out of Anchor and sell the coin.

A reserve fund of about $ 3 billion in bitcoins and other cryptocurrencies is owned by Luna Foundation Guard, a nonprofit co-founded by Terraform founder Kwon.

According to analysts, the sale of so much bitcoin to some extent contributed to the fall in bitcoin prices last week.

Do Kwon, co-founder of Terraform Labs, the company behind the token, announced a “recovery plan” in a series of tweets last week.

Now the company will seek additional funding and rebuild TerraUSD. The token will be backed up by reserves rather than relying on an algorithm.

What does this mean for markets?

Tether, the most popular stablecoin-backed stablecoin, faced a short-lived crisis last week when its price fell from $ 1 to 95 cents.

It has since recovered, but has raised questions about stablecoins and cryptocurrency regulation.

Traditional financial markets have virtually no effect from the collapse of cryptocurrencies. Last week, rating agency Fitch said weak links with regulated markets limit the potential for crypto volatility to cause greater financial instability.

However, central bankers have expressed concern that the collapse of the stablecoin could have wider implications for traditional financial markets.

Treasury Secretary Janet Yellen warned that the fall in the price of Terra showed that stablecoins were “a fast-growing product and risks grow rapidly”, and the US Federal Reserve warned that stablecoins are vulnerable to flight because they are backed by assets during volatility .

Martha Reyes, head of research at crypto-brokerage BEQUANT, said: “Markets are in a state of collapse, but it could allow institutional players to start creating positions and push for stablecoin regulation to provide more confidence.

“While we can’t name the bottom and correlations between asset classes remain elevated, in the past bitcoin has experienced 70-80 percent corrections. This may be an opportunity for institutions to create positions at a higher level.

“Uncertainty around stablecoins is a concern and could lead to another leach, but we can finally get the much-needed regulatory framework that could involve institutions. Regulators tend to react, so this can be a catalyst for greater regulation of stablecoins. ”

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