The Impact of USDT Depegging on the Crypto market

[TL; DR]

The collapse of the TerraUSD was caused by a few large UST withdrawals.

When the UST crashed the prices of major cryptocurrencies such as BTC and ETH decreased in the short run.

The other stablecoins that depegged are Tron’s USD, Fei USD and Neutrino USD.

The best way to hedge against the crash of the USDT is to invest in various cryptocurrencies with different risk levels.


Introduction

There are many blockchain projects that introduced stablecoins to overcome the volatility of cryptocurrencies. As a result, people who want to maintain constant value of their crypto assets buy and hold stablecoins. Also, people use stablecoins when making payments for services rendered or goods purchased since there is no slippage. However, the confidence people have in stablecoins has been shaken by the depegging of the TerraUSDT, an algorithmic stablecoin.


The Depegging of TerraUST

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In May, the TerraUST depegged from the United States dollar creating a ripple effect to the entire crypto economy. Depegging of a stablecoin means that a stablecoin no longer maintains the one-to-one ratio with the underlying asset or currency. For example, a stablecoin pegged to the United States dollar will have a value of less than one dollar. That is what happened to the TerraUSD (UST) whose value dropped below the US dollar.

The collapse of the TerraUSD affected many cryptocurrencies including bitcoin and ETH. For example, the prices of ETH, BTC, LUNA and many others decreased significantly. Notably, the price of TerraUSD dropped to as low as $0.26. Worse still, even the Tether USD (USDT) marginally lost peg to the United States dollar although it recovered later. As a result of the price falls of many cryptocurrencies, the crypto total market capitalization decreased by billions of dollars.
A few transactions involving the UST led to the crash. First, Terra Form Labs withdrew 150 million TerraUSD from three pools as it wanted to transfer the funds to another pool. A few minutes later, another trader exchanged $85 million UST with USDC. Within the next hour, another trader swapped $100 million worth of UST for USDC. However, in a bid to rebalance the ratio of UST Terra Form Labs withdrew a further $100 million from three pools. This string of events created panic among many UST holders who began selling off their holdings.

In all, the public blockchain records show that over $1 billion Tether was redeemed, meaning that the UST tokens were burned. But that was not the end of the story. Again, on 12 June, the UST lost its peg against the United States dollar, with the price slipping down to $0.9975. The reason for this was Celsius, a major crypto lender’s, announcement that it was stopping withdrawals. Also, three stablecoins – Neutrino USD, Tron's USDD, and Fei USD lost peg against the US dollar.


Possibility of depegging of USDT

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We already have a record of the collapse of some stablecoins such as the UST. Already, Tether USD (USDT) has marginally lost peg a few times. Right now, the crypto community is divided on whether or not Tether USD will experience the same scenario as UST. The previous cases of minor USDT depegging indicate the possibility of a greater USDT crash. However that possibility depends on how other economic factors overlap and the extent of the reserves Tether Holdings has.

Currently, around 85% of USDT’s reserves are cash and cash equivalents. The rest of the reserve consists of secured loans, corporate bonds, funds and precious metals, among other investments. Apparently, USDT is most unlikely to depeg as it has increased the amount of treasury holding to over 50% of the company’s total assets. In addition, it has reduced its commercial debts significantly. Significantly, it keeps on giving quarterly updates to its community and investors, something which creates confidence in the coin.

However, the continuing bearish market is straining the stablecoins including USDT very much. The economic factors such as rising inflation and the waning interest rates may further weaken the infrastructure of stablecoins such as USDT. The other factor which can increase the risk of USDT depegging is that the parent company Tether Holdings is lending its reserves which reduces its liquidity.

However, we cannot conclude that USDT may crash based on the case of UST. This is because USDT is backed by the dollar while UST is an algorithmic stablecoin a factor which exacerbated its depegging process.


Impact of USDT depegging on BTC and ETH

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The depegging of USDT would be catastrophic to the cryptocurrency market. This is because many crypto projects have large holdings of USDT since it is the largest stablecoin on the market. In the event of a USDT crash many blockchain based projects may become bankrupt.

In a situation where USDT collapses, there is likely to be a ripple effect on the crypto economy. The prices of BTC and ETH will most likely fall in the short run and rebound in the long run. The main reason why BTC and ETH will not be permanently affected is that they exist on their own infrastructure, not on Tether’s.

However, there is a sad possibility. Since USDT supports many cryptocurrencies, if it collapses many exchanges will shut down and many crypto users will lose their holdings resulting in loss of confidence in cryptocurrencies. It is this loss of confidence in cryptocurrencies which will push their prices down, including that of BTC and ETH.

Furthermore, many traders store their value in the form of Tether USDT. This means that if USDT collapses many traders will lose their personal reserves that support trading. Since, the traders will have little funds; the demand for both ETH and BTC will go down resulting in low prices on the market.


How to survive despite the USDT collapse

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Probably the best way to survive the collapse of USDT is to have a balanced investment portfolio. Analysts advise investors to use a 40-40-20 investment approach.What this means is to invest 40% of your funds in stablecoins like USDT, put another 40% in the cryptocurrencies with moderate risks and the remaining 20% in high risk crypto investment opportunities. In addition, you have to remain highly principled to maintain such an investment plan.


Conclusion

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Since the inception of cryptocurrencies many crypto experts believed that it is best to keep your holdings in stablecoins as they are not susceptible to price volatility. However, the recent depegging of the TerraUSD has shown that stablecoins may lose their values, at times, depending on several dynamics. However, the collapse of UST should not imply that USDT will collapse too. These two stablecoins are built on different infrastructure. The UST is algorithmically backed while the United States dollar backs the USDT. As long as the USDT has enough reserves, it is unlikely to collapse.



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
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