Analysis – Rodrigo Zeidan: Speculative attacks in the cryptoverse

What do the events in cryptocurrencies, the Asian crisis and the devaluation of the real in 1999 have in common?

In all cases, a fixed exchange rate with free flow of capital opened the door to a speculative attack. And just like a central bank that sees its foreign currency reserves draining away, the “monetary authority” or community, if governance is decentralized, of a cryptocurrency has few options: negotiate a bailout, play the interest rate in the stratosphere, institute capital controls or let the currency devalue to a new equilibrium.

The TerraUSD coin is not the first case of an attack on a “stablecoin”, a digital currency whose value is normally pegged to the dollar (1 Earth should be worth US$1), but it is the biggest one so far. Today, there are 12.2 billion Earths in circulation, a potential loss of $12.2 billion for holders of these coins. For comparison purposes, the largest “stablecoin” is tether, with 89 billion digital tokens in circulation.

Terra is an algorithmic currency, with a system of conversion between two tokens based on trust. Stablecoins like the DAI try to maintain the relationship with the dollar by delivering collateral. USDC and USDT use reserves as public or private bonds. Finally, BUSD and USDP have a mandate where they can invest, like fixed income funds, much more restricted to, in theory, be more solid.

The attack on the pound sterling in 1992, the Mexican peso in 1994, the real in 1998-99, the yuan, the Swiss franc and the Danish krone in 2015 and countless others are bets by economic agents against the ability of a central bank to maintain the promise of a fixed exchange rate.

In some cases, the central bank gets away with it, as in Denmark, which imposed capital controls to maintain parity with the euro (while those who bet on the Swiss franc appreciated did well – it rose 25% after the central bank left the bank). it to float). Speculative attacks are rarely coordinated. Public opinion’s condemnation of George Soros’ profits from floating the pound is nothing more than anti-Semitism in disguise.

Anyone who borrows money in one country’s currency to buy low-risk assets in another may be participating in a speculative attack, knowingly or not. After all, if the currency of the country of origin of the loan depreciates, the value of the debt falls, and the investor exits in profit.

In the case of TerraUSD, the epicenter of the attack took place in the Anchor protocol, which promised a 20% return to investors (in Brazil, in 1998, the interest rate rose from 40% —in real terms— to encourage capital flow to the country; it didn’t work either).

As with the 1997 crisis, which started in Thailand and spread across the world, other stablecoins are likely to be attacked as well. A bailout of the financial system is possible. Who will be the cryptoverse IMF?

Part of the cryptocurrency proposal is to bring a new financial system to the world, DeFi (decentralized finance). But it would be good if the governance of the system did not forget the lessons learned by countries that set up fragile fixed exchange rate systems.

Just as these systems can be more or less stable (relying on capital controls, for example), “stablecoins” also follow a hierarchy. The damage can stay only on EarthUSD or spread to the entire planet; and to the Moon (and luna).

I appreciate the valuable comments from André Veloso, cryptocurrency expert.