The crypto crisis and “breaking the buck”

In traditional, non-crypto finance, the phrase “break the buck” has enormous significance with its reference to what happened in September, 2008, and has since become a shorthand way of warning that an enormous financial implosion is underway and regulators had better take quick action.

The term itself refers to when the net asset value of a share in a money market mutual fund dipped below the $US1-a-share price at which it was supposed to hold firm, thereby endangering investors’ principal.

It first happened on September 16, 2008 in the GFC when the Reserve Primary Fund broke the buck when its net asset value (or NAV) fell to 97 US cents a share.

The date is important because it was a day after Lehman Brothers collapsed and the buck-breaking event amplified the Lehman collapse and turned it into a fully-fledged crisis because it cast doubt on every money market fund, of which there were quite a few, as well as the financial health of thousands of investors and fund managers large and small.

While the Reserve Primary Fund held less than 1.5% of its assets in commercial paper issued by Lehman, such was the level of fear among investors, they doubted the fund’s other assets and requests to redeem their investments flooded in and overwhelmed the fund in a matter of hours.

The fund was unable to meet redemption requests and was forced to suspend operations and liquidate. It was one of the first times in the history of investing that a retail money market fund had failed to maintain a $US1 a share NAV. The implications sent shockwaves through the industry, the US financial system and the global financial system.

The Reserve Fund, based in New York, held $US64.8 billion in assets and was the original money market fund, so there was an enormous amount of symbolism in its problems (and its ‘breaking the buck’)

But even its strength could not reassure worried investors who wanted to withdraw their money and quit.

The US government eventually arranged a support package at $US1 a share for the industry, excluding the Reserve Fund – the support steadied the system and reduced fears, along with the massive bailout of banks, insurance companies, car companies and a host of other businesses.

Eventually, for banks generally and other financial groups, the GFC eased and the system survived, rescued but scarred and changed

But the failure of the Reserve Fund and doubt about the stability of the financial groups generally played a part in the emergence of cryptocurrencies, blockchains and other fintech ideas that we read about and hear discussed today.

And yet 14 years or so later, the cryptocurrency industry finds itself in a situation where the buck has effectively been broken by what proponents claimed was a key element that would help anchor the sector’s value – so-called stablecoins whose value is pegged to the US dollar.

Now no one has any idea how to repair the damage and improve the system.

The massive falls in the value of bitcoin, Ethereum and other cryptos has accelerated as the price of so-called stablecoins have imploded with at least two falling below the implied buck value, or $US1.

According to CNBC “Stablecoins are like the bank accounts of the barely regulated crypto world. Digital currency investors often turn to them for safety in times of volatility in the markets.

It has been the plunge in the value of the stablecoin protocol TerraUSD, (or UST as it is known in markets) that has caused the most damage. UST is “supposed to mirror the value of the dollar. But it plummeted to less than 30 cents Wednesday, shaking investors’ confidence in the so-called decentralized finance space,” CNBC reported.

But UST, an “algorithmic” stablecoin that’s underpinned by computer code rather than cash held in a reserve, has struggled to maintain a stable value as holders bolted for the exits en masse.

On Thursday, UST was trading at about 33 US cents, still well below its intended $US1 peg.

The New York Times reported on Thursday that “This week’s implosion of TerraUSD is once again shaking confidence in crypto markets, and raising alarms about investor protection.”

There are few, if any protections, so standby for a lawyers’ feast of legal cases and pressure on Congress to do something when many in Congress, especially Republicans, have been enthusiastic supporters of cryptos because there are no government controls or oversight.

UST’s problems seemed to have flowed from the collapse of Luna, another Terra token that CNBC said was supposed to have “a floating price and is meant to absorb UST price shocks.”

It didn’t and Luna has erased 99% of its value and was last worth just one cent.

“The fallout from Terra’s collapse led to fears of a market contagion, CNBC reported on Friday, Sydney time.

“Tether, the world’s biggest stablecoin, also fell below its $US1 peg on Thursday, falling to a low of 95.11 cents.

Tether is supposed to be backed by $US40 billion in US government bonds and other securities, but on Thursday it refused to release any further details, saying it feared revealing what it called its ’secret sauce’.

“Paolo Ardoino, Tether’s chief technology officer, said on Thursday that the group cannot provide information on which organisation is providing custody of its Treasuries holdings, nor where the assets are stored or which firms handle trading on its behalf,” the Financial Times reported on Thursday.

“This is information that is privileged . . . we don’t want to give our secret sauce,” he said in an interview with the Financial Times. “Our counterparties are not public. We are not a public company. So we keep that information [to] ourselves, but we are working with many big institutions in the traditional financial space.”

“The remarks came hours after the Tether token’s value tumbled below the $1 peg it is designed to target, raising further concern about the financial stability and transparency in the fast-growing market for stablecoins,” the FT reported.

It has long been a fear of economists and other observers that Tether may not have the required reserves to support its dollar peg in the event of mass withdrawals.

Now this refusal to detail the reserves (as a bank would have to) is adding to these fears about the stability of stablecoins and through them, the stability of all cryptos.

All this has seen most cryptos fall. Bitcoin, as the best known, grabs the attention and its price movements get more widely reported.

Thursday saw the value of Bitcoin fall below $US26,000 for the first time in 16 months, amid a broader sell-off in cryptocurrencies that CNBC said wiped out more than $US200 billion from the entire market in a single day.

Remember Bitcoin peaked at $US68,000 and some analysts say everyone who bought from 2020 onwards is now under water.

The price of bitcoin plunged as low as $US25,401.29 on Thursday morning, according to Coin Metrics. That marks the first time the cryptocurrency has sunk below the $US27,000 level since December 26, 2020.

Bitcoin rebounded a bit and has been trading at $US28,358.58, down 3.6%.

The Financial Times said this was the biggest crisis to hit the crypto sector since the Chinese government expelled foreign crypto miners 16 months ago.

While that was a brief hiccup as prices rebounded, the failure of the stablecoin system has sent real shockwaves through the sector and raised very real doubts that hundreds of billions of dollars have been wiped out and lost.

The paper explained that Tether’s tokens are intended to be pegged to the dollar and so act “as a crucial part of the plumbing of the cryptocurrency market because they make it easier for traders to hop between digital and traditional finance.”

“Operators say they hold enough reserves to guarantee every coin produced, typically 1-for-1,” according to the FT.

Tether has had $US2 billion in redemption requests in the last day, an unusually high number, Ardoino told the paper.

With total assets around $US80 billion, the FT said Tether would rank alongside some of the biggest hedge funds in the world. Its declared $US40 billion holdings of US debt mean it holds a similar amount to Vietnam.

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