21Shares Market Update: Risks And Silver Linings in A Risk-Off Environment

What is happening with the cryptoassets markets?

• On May 12th, the entire crypto market experienced a significant and systemic market crash, the biggest since the China ban— down 14% within 24 hours.
• The systemic risk that has been triggered by the collapse of Terra’s non-collateralized and algorithmic stablecoin pegged to $1, called UST. The assets under management of the Terra ecosystem were concentrated by up to 69% on Anchor — a money market application offering yield on UST with eligible collateral, including interest-bearing derivatives (ie, staking tokens) of Terra’s native token LUNA and Ethereum’s Ether. At its peak, Anchor held $31 billion in assets. Within the last 7 days, the application lost 89% of its assets under management, down to $1.7 billion.
• Anchor’s product-market fit relies on the success of UST and the security of the Terra network. With billions of dollars at stake and this level of concentrated AUM in one application, Anchor effectively represents a systemic risk for the Terra ecosystem and investors, DAOs, and funds with fiduciary duty using this app.
• Other stablecoins, mainly non-collateralised, which lost their peg, never recovered, including Empty Set Dollar, Dynamic Set Dollar, and Basis Cash. Terra’s UST is yet another example. The solution to this flawed stablecoin design may be 1) full collateralization and 2) separation of LUNA from UST. But restoring faith from investors may be a long process. LUNA currently trades at $0.02, down 99% in 24 hours with -/+2% market depth of only $14K (a week ago, the market depth accounted for millions of US dollars) on the largest exchange, Binance, where +50% of the volume occurs.
• UST completely lost the peg — down +60% from the $1 mark, trading at $0.40.
• The market crash has escalated due to $1.2 billion in total liquidations on the futures market and billions of dollars converted from UST and LUNA to more reliable stablecoins, including Circle’s USDC and fiat currencies.
• The latest proposal from Terraform Labs may be burning the 1 billion UST from the Community and 371 million UST from Ethereum, initially allocated for liquidity incentives. Furthermore, 240 million LUNA may also be staked to secure the network.
• Alt L1s previously part of the SOL-LUN-AVAX ‘Ethereum killer’ category may be leading the losses, and other L1s such as Fantom. In 24 hours, Solana lost around $9B, Avalanche lost $4B, while Fantom also lost around $4B - all three losing approximately 40% of their value in hours.
• DeFi markets are also correcting sharply in correlation with the broader market. The Total value locked (TVL) of the DeFi sector dropped 28% compared to last month. The DeFi ecosystem in Terra dropped 67% in TVL, Fantom dropped 45%, Avalanche dropped 30%, and Solana dropped 27% compared to last month.
• The largest stablecoin Tether’s USDT depegged briefly to $0.95 and encountered huge selling pressure in one of the largest Decentralised Exchange Stablecoin Pool (3-pool on Curve)

Why is this happening?

• There are two primary causes for this episode
  • First, the broader risk-off macro-environment due to a hawkish Fed responding to rising inflation levels in the US, the Russo-Ukraine conflict, as well as post-covid economic difficulties including strained supply chains across the world.
  • Second is the ripple effect of the downfall of UST. The key victims include Layer-1 blockchains with close ties with UST and Tether’s stablecoin, USDT.
• Within the large Layer-1 blockchains aside from Terra, UST has most of its presence on Avalanche, Solana, and Fantom. UST's circulating supply accounted for 1% of the network’s total value locked (TVL), respectively.
• USDT selloff on Curve Finance intensified. USDT percentages in the DAI-USDC-USDT swap pool increased from 28.42% to 92.63% from 5 May to 12 May. USDT lost its peg briefly to $0.95.

What are the risks?

• The greatest risk could be insufficient collateral to redeem US dollars against Tether’s USDT, essentially the reserve currency of the cryptocurrency economy at ~ $82B in market value. This is unlikely, but we are monitoring the situation and risk closely, as Tether's last transparency report was published last December here.
• The second most significant risk is significant losses affecting the Ethereum competitors and their ecosystems, especially Terra.
• Fantom is the most vulnerable ecosystem, with the recent exit of one of its founders, Andre Cronje affecting narratives around it.
• Avalanche and Solana also have significant exposure to the collapse of Terra’s stablecoin due to exposure to UST in their DeFi ecosystems.

What is the silver lining?

Despite short-term fluctuations, the silver lining is the fundamentals could be seen as stronger than ever

• Less than 5% of the Internet population has access to crypto: +200M crypto users, akin to the Internet adoption in 1998. However, this user base grows faster than any other technological adoption rate. There are 170M Ethereum wallets — up 300% YoY
• Stablecoins’ supply up 388% YoY
• DeFi’s TVL skyrocketed to $250B.
• The Great Resignation may benefit crypto. There's a labor tightness, and talents increasingly leave tech giants and traditional finance to build and work in crypto
• 65% of the active developers joined Web 3 in 2021 to improve the infrastructure and launch financial and entertainment applications.
• The level of understanding about crypto from government officials is at an all-time high.