Anatomy of a Stablecoin's failure: the Terra-Luna case: Relevance for stakeholders

Table of Links

Abstract and 1. Introduction

2. Data and quantitative nature of the events

2.1. Hourly data analysis

2.2. Transaction data analysis

2.3. Anchor protocol

3. Methodology

3.1. Network analysis: Triangulated Maximally Filtered Graph (TMFG)

3.2. Herding analysis

4. Results

4.1. Correlations and network analysis

4.2. Herding analysis: CSAD approach

5. Robustness analysis

6. Implications and future research

6.1. Relevance for stakeholders

6.2. Future lines of research

7. Conclusion, Acknowledgements, and References

Supplementary Material

6. Implications and future research

6.1. Relevance for stakeholders

Considering that the failure of large stablecoins built upon inappropriate decentralized finance frameworks (e.g. lack of collateral and dependencies with liquidity providers) could give rise to potential financial stability risks, we believe that our results are relevant for both investors and policymakers. Applications of stablecoins within the crypto space remarkably increased since 2020, while poorly supported by adequate regulation. Initially, they were used as: (i) bridge between fiat currencies and crypto-assets; (ii) “parking space” for crypto volatility (Adachi et al., 2022). Nowadays, they are also used to provide most of the liquidity in DeFi applications such as decentralised exchanges and lending protocols (e.g. UST and Anchor protocol). Consequently, stablecoins play a critical role within the crypto space, where they are involved in almost 75% of the entire trading (Adachi et al., 2021). Largest stablecoins represent a primary source of risk according to the European Central Bank (ECB), which states that a “bank run” on Tether could disrupt trading and price discovery in crypto-asset markets, which could turn disorderly (ECB, 2022). Therefore, even though the collapse of UST was not able to rise relevant herding effects, the failure of larger stablecoins could generate systemic effects on the whole crypto universe. In addition, considering the growing interlinks between crypto-assets and the traditional financial system, the failure of stablecoins could also have implications external to the crypto space. These scenarios remark the need for a Global Stablecoin Standard and continuously updated regulations able to guarantee (i) a process for fulfilling holders’ redemption claims, (ii) proper transparency of reserve asset composition and (iii) development of appropriate risk-management frameworks. Relevant regulatory standard-setting bodies (Financial Stability Board and Bank of International Settlements; see, e.g. Bank for International Settlements, 2022) and governments (Japan, Hong Kong, United Kingdom, European Union and the United States; see, e.g. Asmakov, 2022, European Council, 2022) are already proposing robust rules for these digital assets. It would be beneficial that contributions from inside the DeFi community would also be proposed.