We could excuse you if you missed the crypto crash that has been happening alongside the stock market carnage we highlighted last week. And this makes sense because crypto has a long history of crashes and rallies in its short history.
Usually, when these are discussed we are referring to the most popular and largest cryptocurrencies in the marketplace like Bitcoin and Ethereum. In fact, we even highlighted the risk and subsequent actions we personally took in November to diversify away from Bitcoin in an effort to sleep more soundly at night amid the wild swings. (If you would like to congratulate me for my excellent trade, please take a moment to do so now)
What makes this current crypto story unique is that smaller coins called Luna and its associated “stable-coin” UST were the center of attention, not Bitcoin. Assuming most of you do not know what Luna or UST is, let's take a look at what a stable coin is in general first.
A stable coin is a type of Cryptocurrency that is “pegged” to a price meaning that 1 stablecoin is always supposed to be worth 1 US Dollar. This is a valuable tool for trading amongst cryptocurrencies because you can move money to them in times of volatility or use them to transfer money across different cryptocurrencies. Most of the popular stable coins like Tether (USDT) or USD Coin (USDC) are backed by, or at least claimed to be backed by, real money. You know the US Dollar that they both use in their ticker symbols to convey that it is in fact real money and you can trust them.
While I am very skeptical that either of those coins actually has real backing, they have both acquired $50+ BILLION in deposits from people.
So if these coins are merely worth $1 and will theoretically always be worth $1 why do people have $100+ billion in these stable coins? As we mentioned before they are often used for trading crypto, storing money temporarily, or back in the day for avoiding taxes. But none of these reasons add up to $100 billion, and that is where UST and Luna come in.
We spoke back in September about how Coinbase (the world’s largest crypto exchange) was trying to advertise a savings account type product that offered 4%. At the time we highlighted that this was a blatant misrepresentation of what this type of account was. The part we merely alluded to however was that other companies like Terra and Anchor who use Luna and UST were paying 19% interest on deposits in their “stable-coin” UST. With savings rates on your bank account still yielding microscopic rates like 0.01% it seemed like a no-brainer to flood money into these stable coins and people did with UST reaching nearly $20 billion.
There was a key question that most people investing in this overlooked or outright ignored when blinded by the chance to earn 19% in a “savings” account. And that question was…
How in the actual F&%k is that possible?
Bank accounts can’t pay that, mortgages are like 5%, hell the average rate of a credit card (the worst kind of debt) is less than 19%.
The short answer is they were never able to safely pay that amount, and if you read the fine print they knew that they just hid behind fancy words like “over collateralized loans” or “algorithmic stable coins” all eerily reminiscent of buzzwords that you would read in a subprime collateralized mortgage obligation from the 2008-2009 housing crash.
If we teach you nothing else in this blog, it's that if it sounds too good to be true it probably is.
In this case that was more true than ever, unlike the already sketchy Tether or USD Coins, Terra (UST) didn’t even bother to actually hold any cash reserves. They relied on an algorithm that would allow users to exchange 1 UST for $1 worth of LUNA at any time. This meant traders would come in and buy UST if it fell to even 99 cents and exchange it for $1 LUNA making a quick risk-free $0.01 which adds up if done consistently but what happens when LUNA drops…
Yes, that is correct Luna was worth nearly $100 and is now worth $0.00014 which is a lot of zeros, but not in the good way. And then…
The “Stable-coin” always supposed to be worth $1 is now worthless, trading around 8 cents at the time of writing. All those claims of stability and 19% returns just evaporated in the blink of an eye. Wiping out roughly $15 billion dollars of savings of UST depositors.
What’s the Upside?
While crypto and DeFi have already pushed traditional banking to improve their offerings and underlying technology, these are not magical coins that make people rich. At the end of the day, anytime you are lending money even with “over collateralized algorithms” risk exists and this UST saga was a prime example of it.
We still believe crypto will play a role in the future but hope this moment in time makes people realize, that if it sounds too good to be true it probably is. And with that in mind, we hope you keep reading this blog which highlighted these risks 6 months ago, and even more important that anytime you invest your money you take the time to consider the risks and understand what you are investing in.
For Your Weekend
Our round-up of essays, podcasts, and streaming shows to check out over your weekend. We cast a wide net so you don’t have to.
It’s Time to Stop Giving Crypto Companies a Pass by Richard Goldberg (The Dispatch)
The young industry is pushing back on attempts at regulation, but it’s undeniable that crypto is used for sanctions evasion and illicit activity.
The Lost City (Paramount +, others)
Now that it’s streaming on Paramount+, you have no excuse to keep sleeping on The Lost City, arguably the best adventure comedy since the Jumanji remake. The jokes are laugh-out-loud funny, but the real magic comes from the chemistry—both romantic and comedic—between leads Sandra Bullock and Channing Tatum. Both are in top form in roles that are perfect for them: the too-smart-for-this-bullshit romance author (Bullock) and the sweet-but-simple male model himbo (Tatum). Through a series of surprisingly believable events, the two end up lost in a deadly jungle together. Daniel Radcliffe ties it all together as the hilarious maniacal billionaire with an inferiority complex, proving what Harry Potter fans already knew—that dude is freakin’ funny. It’s a guaranteed laugh and a nice reminder that Bullock is still the rom-com queen (Anna Menta)