Not your 🔑 not your coins + The Terra meltdown explained 🌘
Gm 1Walletoors
These past few days have been quite the year…. And we got lots of ground to cover, so here’s what we are diving into this week:
🔑 Laws of the custodial lands - Coinbase makes it clear that there is no “I” in team
😭 The stale stablecoin storytale - The collapse of the Terra Empire
🍨 Sweet Scoop: What makes a stablecoin stable?
📲1W Updates: Create and share polls in seconds
Hide your kids, hide your w-allets
😟 Coinbase lets users know they hold the keys
Coinbase is having a terrible year — share prices are down over 70% year-to-date, and to add insult to injury, is now warning its 98m customers that in the event it ever declares bankruptcy, the $256 billion assets it holds in custody on behalf of its customers could be subject to bankruptcy proceedings. In short, Coinbase user funds can be seized and become inaccessible. How is that possible? And more importantly, is this true for all wallets?
Remember the house and key analogy? Imagine your wallet is your house. With a non-custodial house (1Wallet), you own your (private) key at all times. With a custodial house (wallet), your (private) key is controlled by a third party custodian (Coinbase). Since Coinbase holds the (private) key to your house (wallet), it can lock you out of your own house (wallet), and in the event of bankruptcy, it could hand over the (private) key and the mattress full of crypto assets the house (wallet) contains to the bank (creditor). So what we say rings truer than ever... “Not your keys, not your coins!” With a non-custodial wallet, including your 1Wallet, you have sole control of your private key and retain full custody (possession) of your crypto assets at all times. Of course, with great power comes great responsibility! Since you’re the only one with access to your key, you need to manage your wallet carefully, including proper wallet backup.
A Series of Unfortunate Events
💰 One of the largest token crashes explained
The crypto market has been on a historic rollercoaster ride full of volatility and chaos, with the blackest of the black swan events – a total collapse of two top 10 crypto assets by market cap (Terra $LUNA and stablecoin Terra $UST) – resulting in over $40 billion being wiped out over a mere span of few days. So what happened? Let’s start by understanding the LUNA - UST seesaw mechanics and how the immense popularity of its Anchor lending program that promised almost 20% APY may have contributed to its rise and its ultimate demise.
Crypto is infamously volatile but stablecoins are designed in such a way to hold their value, a peg against the dollar (1 UST = $1). For an algorithmic stablecoin like UST, it helps to use a seesaw analogy. Imagine LUNA as UST’s sister on one end of the seesaw with the task of making sure her sister remains balanced and pegged to the US dollar. To ensure the seesaw and the balance, each time her sister mints (creates) a UST, the equivalent of $1 LUNA is burned (removed) from the circulation and vice versa. In effect, this means that the LUNA supply contracts (supply gets smaller resulting in price increase) when there is demand for UST, and expands when the demand falls, in order to keep the little sister UST balanced.
To ramp up the demand, Terra created a DeFi product (Anchor), enticing users with its sweet (but unsustainable) 19.46% yield. Users salivated over the high yield and UST-exclusivity further created a massive demand for UST. Both LUNA and UST shot to the top 10 crypto asset ranking by market cap with over 70% of UST ($13 billion) locked up in Anchor. While no single event triggered a downward death spiral of the past week, a run on the bank (everyone wants out of UST) doomsday scenario did play out when hundreds of millions of dollars of both UST and LUNA were rapidly sold across exchanges causing market wide panic selling, resulting in even more massive withdrawals. As LUNA should, she created more tokens to make her sister balance amid the chaos. But this time, when she tried she struggled (market was already spiraling down), so as she was trying to bring the value of her sister back to $1, her token supply hyperinflated from 725 million to 7 trillion in two days. This reduced her token value from $67 to $.0015, effectively collapsing it. She even sold her father’s (The Luna Foundation Guard) $3.5 billion Bitcoin reserves as a final attempt to rebalance her sister, but failed and was unable to restore the 1:1 peg, which led to the seesaw being so unbalanced that it broke, with the sisters falling off of it (essentially going to 0). Lesson: The algorithmic stablecoin is inherently fragile and when something sounds too good to be true, it unfortunately probably is.
🍨Sweet Scoop: What makes a stablecoin stable, and how is a coin that is stable trustworthy?
Stablecoins represent a sizable portion of the total market cap of all crypto assets with the top 5 capturing more than $135 billion in value between USDT, USDC, BUSD, DAI, and previously UST. They come in many flavors but can be largely broken down into:
1) Collateralized (USDT, USDC, BUSD) - backed by and pegged to fiat (USD) at a 1:1 ratio
2) Algorithmic (UST) - seesaw algorithm to balance supply to maintain a 1:1 peg to the dollar
3) Crypto-over-collateralized (DAI) - backed by user depositing more crypto assets than that of the stablecoin amount to account for market volatility
On the momentum of UST de-pegging news, the market expressed fear over the quality of other stablecoins, namely Tether (USDT), the largest stablecoin by market cap but often criticized for its opaque operations. To its credit, however, Tether has maintained its peg through multiple black swan events and has always honored a redemption request (request to exchange USDT for USD) from its customers, most recently to the tune of $8 billion. To further calm the market, Tether issued an audit report which showed a basket of assets it holds to maintain the peg. The assets it holds to maintain the peg contrasts that of USDC which is fully backed by cash and US Treasuries so that it is always redeemable 1:1 for US dollars, which explains why USDC is the biggest beneficiary of USDT redemption requests.
The UST/LUNA debacle has led to many wondering if this was the nail in the coffin for already wavering trust in stablecoins, with institutions like the U.S Treasury Secretary calling for more stablecoin regulation. However many believe that while this is a massive bump in the road, other stablecoins will come out stronger. But which can we trust? Only time will tell….
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See you soon,
1Walletees
P.s. Happy 10th birthday, Coinbase 🎂 #wagmi