S3T May 15: Terra tumbles, stablecoin types, Soros attacks, Crypto policy, Napster and web3 music, anemones, enzyme recyclers...

Harsh lessons from the trial and error in digital currency innovation. Amid tough uncertain times stakeholders adjust, adopt and continue to test and learn how to leverage new capabilities for good.

Stablecoins have 1 Job

The fall of Terra

This week witnessed a historic and harsh lesson about a specific type of stablecoin that attempts to maintain value without being backed by collateral. This is not the first time this type of stablecoin - known as algorithmic stablecoins or algostables - has failed, but it is by far the most catastrophic.

The algorithmic stablecoin known as Terra (UST) collapsed this week, causing complete losses for holders of the coin, and wiping out billions of dollars of value. As of Friday, exchanges were delisting Terra and the Terra founder's family were fearing for their lives.

Amid the soundbytes and headlines there are some easy to miss key details that need to be understood. Terra does not represent stablecoins nor is it a good representative of the spectrum of worthy crypto capabilities being developed and adopted.

Key points to understand

Stablecoins are digital assets that are intended to stay pegged to a unit of currency - usually the US Dollar. There are - so far - two basic kinds of stablecoins:

• Collateral Backed Stablecoins - the value of these stablecoins is backed by collateral equal to at least the number of stablecoins in existence.
• Algorithmic Stablecoins - the value of these stablecoins is not 100% backed by collateral. Instead an algorithm attempts to maintain the peg through a set of adjacent mechanisms.

Terra (UST) was an algorithmic Stablecoin. Another algorithmic stablecoin experiment ended badly last summer, impacting Mark Cuban and others. Good comparison of that implosion with this week's events here.

Terra had been warned

Late last year, concerns were raised about the vulnerability of Terra to the so called Soros attack, and the ability of its algorithmic mechanism to stay pegged to the dollar. In response to this concern, the Terra founder fired back this belittling response (See also the Jan 29 2022 tweet below). No wonder that Terra's meltdown this week evoked a long list of told-you-so statements from the cypto community.  

Possibility of a Soros Attack

In the wake of the Terra implosion this week, reports surfaced that indeed a Soros attack may have been responsible for starting the mayhem. Here is one step by step explanation of how the alledged (and so far unconfirmed) Soros attack against Terra was executed day by day this week. The Soros attack refers to coordinated trading strategy that George Soros and a set of partners successfully executed against the British Pound in September 1992. Further reading:

• Good summary and explainer of the attack and how it impacted markets
• Atlantic excerpt from a book on the attack. - play by play of London's attempts to manage the situation.  
• Guardian's retrospective - a UK perspective 20 years later

Aftermath and Knock on Effects

The Terra implosion had a marked impact on the financial ecosystem this week. Last weekend BTC was trading in the mid 30's. This week it plunged to ~25K, recovering to ~29K this weekend. The downward pull on the price of BTC was predicted last month by the ever sharp Lyn Alden, as noted in her tweet below.  

Longer term, expect this week's events to influence the regulatory response to stablecoins. As more critical functions and uses of capital (beyond opportunitistic speculation ) come to rely on these newer mechanisms we need to have a well developed understanding of how they work and how they can break.

If the Soros attack is confirmed to be the culprit that started the Terra implosion, this raises an interesting pair of questions:

• Was Terra a flawed innovation that was always destined to go off the rails at some point? Was it "just a matter of time" as with the Wall Street innovations that drove the crash of 2008? OR
• Was Terra a risky but feasible ecosystem that was brought down by a determined malicious actor?

Either way, we need a path of inquiry and learning into the "design principles" and best practices to follow when building crypto capabilities that must be trustworthy for families, businesses and governments. The DeFi space offers abundant opportunities for use of creative financial instruments. How much time do DeFi developers spend thinking about how someone could misuse these instruments and what damage they could bring?

Not all Collateral Backed Stablecoins are Created Equal

While Collateral Backed Stablecoins survived unscathed this week, there are some important distinctions to point out:

• Collateral backed stablecoins that are independently audited and able to prove sufficient assets have so far shown an ability to remain stable. Throughout the Terra debacle this week, DAI stayed pegged at $1.00 - even briefly jumping to $1.01. Likewise no concerns emerged for USDC.
• Tether is another collateral backed stablecoin, but over its history concerns have persisted about the transparency and the sufficiency of its backing. This week Tether's price dropped briefly to 95 cents, but has since regained its peg to the dollar.
• Important to note that even the most transparent and thoroughly audited collateral backed stablecoins are not entirely free of risk, and are not FDIC insured.

Collateral backed stablecoins seem to have emerged - at least from this week - as the superior choice for stability. But it is worthwhile to consider:  

• What risks are integral to collateral backed stablecoins when they are regularly subjected to independent audits to confirm their collateral sufficiency?
• What additional mechanisms might be necessary?

Summary

I trust that regulators and policymakers will recognize the difference between collateral backed vs algorithmic stablecoins (also sometimes referred to as "algostables"), and consider how best to work with the industry to make sure that collateral backed stablecoins provide value to our communities to their fullest potential. SEC official Hester Peirce's comments this week offer a way forward.

I also think there is another longer conversation to be had about why some in the crypto space believed so passionately that algorithmic stablecoins were absolutely necessary, while rejecting collateral backed stablecoins. I think it may have something to do with very different ways that these 2 stablecoin types relate to central banks, fiat monetary systems and specifically what some might call the biggest algorithmic stablecoin of them all - the Almighty Dollar. I hope to unpack this further in future editions of S3T.

Global Scan: Crypto Policy Developments

Alongside the market drama with Terra, a number of other developments indicate continued adoption of crypto platforms and policies. A few notable examples:  

• Brazil's largest investment broker launches bitcoin trading for its 3.5m customers in partnership with Nasdaq
• China's courts issue a curious verdict declaring bitcoin to be a virtual asset protected by Chinese law.
• Germany establishes a crypto friendly tax policy

Governments are recognizing that the new financial ecosystem - as unformed and untamed as it may be - is here to stay. We have to learn together how best to use these new financial building blocks to build a wealthier healthier world.

Remember Napster? Web3 Music

Napster has been acquired by the Hivemind and Algorand as part of a plan to create a Web3 music business.

If you're wondering how Web3 could change the music business, start with this helpful explainer from The Drum. In short, Web3 offers advantages to artists that are just not available from Web2 and its big tech driven business models. And...think about the Metaverse as a giant music venue.

NFT Now has assembled a guide to Web3 music including streaming services and NFT music marketplaces.

Nature Notes

New insight on exactly why some sunscreen ingredients are bad for coral reefs - Apparently sea anemones process the sunscreen ingredient oxybenzone in a way that "inadvertently turns oxybenzone into a molecule that — instead of blocking UV light — is activated by sunlight to produce free radicals that can bleach and kill corals."

Environmental Innovation - this AI engineered enzyme delivers best performance of any approach so far at recycling plastic - completely consuming entire plastic containers. Impressive that these are off-the-shelf kinds of containers from local stores, rather than the "lab plastic" often used in these kinds of experiments.

Final Note

Thanks to everyone who came out to the DHIT Happy Hour this week! Really exciting to see the energy and passion for healthcare innovation as evidence by the work and projects shared.  Please consider attending the next one which will be in Charlotte May 18. Details here.

Thanks again for reading and sharing. Hope you are all S3T for success this week! Feel free to forward this to a friend and continue the conversation on the S3T Discord, Twitter or LinkedIn.

Ralph

Opinions mine. Not financial advice. I may hold assets discussed.