Terra-Luna Fiasco: Will The History Repeat Itself?

By June 29, 2022August 10th, 20224 minute read
Terra-Luna Fiasco: Will The History Repeat Itself?
Note: This blog is written by an external blogger. The views and opinions expressed within this post belong solely to the author.

Hedge funds are possibly shorting Tether, the biggest stablecoin in the world. This occurs when the market continues to experience a sharp sell-off following the Terra-Luna fiasco.

According to a Wall Street Journal report, major cryptocurrency brokerage platforms have been used by more conventional hedge funds to execute bets to short Tether. These trades have a “hundreds of millions” dollar value. It will be exciting to observe how things develop. Let’s take a look at the current situation till then.

Before we move forward, a few terms and definitions may need quick introductions throughout the blog. So we’ll be looking at them at short intervals.

What is shorting?

Shorting or short-selling means selling a cryptocurrency to later buy it back at a lower price. Traders can then benefit from the price difference in the market. The familiar adage “buy low, sell high” is flipped on its head by short-selling; instead of buying low, selling high, the trader sells the asset first, then repurchases them later.

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What are Crypto hedge funds?

Unlike a cryptocurrency index fund, an ETF, or an exchange, a hedge fund is a discrete way for a person to invest in a significant set of underlying securities. These are monitored by a group of knowledgable investors, periodically rebalanced, and subjected to extensive analysis. Profits from these specialists’ market moves go to investors.

In other words, hedge funds are financial holding firms where investors deposit their money in exchange for the promise of active returns from either shorting or holding long positions.

What happens when hedge funds short cryptocurrencies?

It starts like this: Hedge funds that short stocks, commodities, or cryptocurrencies have a strong interest in seeing the value of their target decline, and they frequently aid this via a variety of strategies, making the public aware of what they believe to be a weakness in particular.

There are two issues here. First, unlike with a typical cryptocurrency, you are not expecting the price of a stablecoin would decrease when you short it. Instead, you are placing a bet on it that it will break the buck or lose its dollar peg. This might result in a confidence-based collapse that would be quicker and more difficult to halt than any bank, as several authorities worldwide have long warned.

This is what happened to TerraUSD, which had been the third most valuable stablecoin and took just a week to practically lose all of its value. It also impacted Tether, with USDT surpassing the $1 mark and momentarily falling to $0.95.

Now, let’s see what’s happening with Tether and why its CTO took it to Twitter and refuted all the claims by hedge funds.

Shorting Tether: What’s exactly happening?

Hedge funds are shorting Tether as a result of the Federal Reserve hiking interest rates by 0.75% to restrict the supply of dollars and thereby limit inflation. According to the report, hedge funds think since Tether is pegged to the US dollar, it should also affect the Tether stablecoin. Other hedge funds are worried about whether any assets are supporting Tether in the meanwhile.

However, Tether’s CTO, Paolo Ardoino, responded to all of the hedge funds’ accusations on Twitter. Ardoino mentioned all the strategies adopted by traditional finance to short Tether. He also added that to destroy Tether’s reputation and cause a black swan event, “competitors were spreading via coordinated troll networks.”

Source: Twitter

It is important to note that Tether might de-peg from its value and lead to another stablecoin meltdown if hedge funds decide to short it. However, unlike Terra-Luna, it is not an algo stablecoin which means real assets back it.

Algorithmic stablecoins, in their most basic form, are fully uncollateralized. Therefore, they have no outside asset to support their worth. To read more about them, click here.

What does Tether have to say here?

A few hours later, Paolo Ardoino, the CTO of Tether, used Twitter to disprove the methodology and justification used by hedge funds to short USDT. In a Twitter thread, he described the methods that traditional finance used to short the world’s largest stablecoin by market cap.

Source: Twitter

Tether showed a record for liquidity after a bank ran on its holdings following Terra’s collapse. A mere 5% run on a U.K. bank’s assets in 2007 led to a government bailout and the bank’s eventual transfer to state control.

Given that $16 billion, or almost 20% of its market worth, has been taken out of Tether over the previous month with no public reports of redemptions, it is clear that Tether has sustained more significant pressure over a shorter length of time without experiencing any apparent problems.

The Wall Street Journal cited a $16 billion drop in Tether’s market worth, which is now at $67 billion, but did not mention how that would have affected its reserves.

Is there some regulatory pressure over Tether?

Tether has previously been under regulatory investigation in the past and has been heavily questioned about the assets and reserves that support the coin’s value. The New York attorney general’s office accused Tether of making several public misrepresentations about the dollar reserves supporting it, and the two parties came to an $18.5 million settlement in 2021. However, Tether didn’t acknowledge or reject any of the charges at the time. It has been in constant denial of all the rumors related to its portfolio of commercial papers. 

As redemptions increase, the market capitalization of Tether has fallen below $70 billion at this moment. However, according to CoinMarketCap, Tether’s price is $1, which is still linked to the USD.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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Shashank

Shashank

Shashank is an ETH maximalist who bought his first crypto in 2013. He's also a digital marketing entrepreneur, a cosmology enthusiast, and DJ.

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