Crypto’s “Lehman” Moment Eviscerates Terra’s UST, Pummels Bitcoin, and Shakes up Tether

Rohail Saleem

This is not investment advice. The author has no position in any of the stocks mentioned. Wccftech.com has a disclosure and ethics policy.

Bitcoin (BTC), the world's premier cryptocurrency, has now fallen to price levels below December 2020 lows, as the mess that is Terra's UST is unleashing whale-sized volatility quakes across the entire crypto sphere. At its lows today, Bitcoin was trading around the $25,000 price handle.

Heading into yesterday's US CPI report, animal spirits were reawakening across wide swathes of the risk asset universe amid expectations that the report would show that the peak inflation was now behind us, setting the stage for a gradual reduction in Federal Reserve's hawkish stance that has hammered equities, bonds, and cryptos alike. However, contrary to expectations, the CPI report again showed red-hot inflation for the month of April, dragging equities down as investors see no policy support on the horizon as long as inflation remains near multi-decadal highs. We have continued to hammer on the fact that Bitcoin's soaring correlation with high-beta US equities means that the cryptocurrency will not be able to recover from its price swoon until the broader market does.

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Against this backdrop, Terra's UST has played its part in damaging the prevailing investor sentiment not just around the stablecoin's counterpart LUNA but also around the entire crypto sphere. Quite frankly, this liquidation wave does feel like a "Lehman" moment for cryptocurrencies.

As a refresher, TerraUSD (UST) is a stablecoin pegged to the US Dollar. Terra maintains this peg by algorithmically adjusting the supply of UST and LUNA. If the price of UST falls below $1, the supply of UST is burnt by minting LUNA, thereby restoring the peg. On the other hand, if the price of UST exceeds $1, LUNA is burnt to mint more UST, thus increasing the stablecoin's supply and reducing its price. Terra is also planning to introduce a Bitcoin-based stabilization mechanism.

Bitcoin Crisis
Bitcoin Crisis

This brings us to the crux of the matter. A few days back, UST began to fall from its $1 peg, requiring Terra to burn UST by minting LUNA. However, the scale of UST liquidation was such that the peg could not be restored even though large quantities of LUNA were being minted at lower and lower prices. This crisis has laid bare the futility of issuing algorithmically adjusted stablecoins, and Terra itself appears to be moving toward incorporating some reserve-based mechanism as a crucial stabilization tool. In the throes of this crisis, Terra also loaned out Bitcoin worth $750 million to OTC traders, who were then asked to buy UST. This intervention also failed, which exacerbated the confidence crisis in the entire crypto sphere.

Source: https://coinmarketcap.com/currencies/tether/

Well, the crisis just hit Tether (USDT), which has also now de-pegged from its $1 theoretical price, currently trading at around $0.96 as liquidations escalate.

Source: Coinmetrics

A few days back, we had noted the probability of Bitcoin going below the $29,000 price level was remote, citing a number of proximal support zones as well as the prevalence of oversold conditions. However, in light of yesterday's CPI report and a historic-high correlation between Bitcoin and US equities, the capitulation levels for a sustainable recovery are now likely much lower. As is evident from the snippet above, that correlation just hit 0.71, indicating that around 71 percent of the moves in Bitcoin follow those of the S&P 500 index. This correlation regime means that Bitcoin and US equities will continue to face similar liquidation waves in the near future.

Finally, Bitcoin has always formed a new all-time high after a capitulation event. Will this time be different? Time will tell, I guess.

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