Thursday, May 12, 2022

Driverless Finance | Fintech & Capital Intermediation

After the end-of-semester crunch and a bout with Covid, I'm back to reading Hilary Allen's Driverless Finance.  Chapter three, focused on Fintech and Capital intermediation seems prophetic today.  In it, she explains how stablecoins could lead to fiat currency runs and fluctuations.  She also explains how concerns about a particular cryptoasset could trigger panics affecting other cryptoassets.

This brings me to our world today.  TerraUSD, a stablecoin, has become unstable.  It aimed to hold its value at $1 per coin to allow crypto enthusiasts to park cryptoassets in TerraUSD, avoiding market fluctuations.  For most of the past year, TerraUSD largely achieved this goal.  But then it didn't.  As of Wednesday, TerraUSD traded at $0.23.  To help readers see the carnage, check out these charts, first the year and then the last seven days.

TerraUSD 1Y

TerraUSD 7d

Allen predicted that these sorts of things could happen.  The Wall Street Journal described the panic briefly spreading to another stablecoin, explaining that the "collapse saddled investors with billions of dollars in losses. It ricocheted back into other cryptocurrencies, helping drive down the price of bitcoin. Another stablecoin, tether, edged down to as low as 96 cents on Thursday before regaining its peg to the dollar."

Allen also warned about the dangers to the financial system if cryptoassets served as collateral for institutional borrowing.  We can see some of the risks today with cryptoasset declines potentially causing retail investors to sell out of traditional equity securities.  Some retail traders already access margin loans with cryptocollateral. We're also seeing significant declines in crytocurrencies now.   This may drive significant selling activity.  

Ultimately, the events strengthen Allen's argument that we must manage financial stability risks arising from these new financial assets.

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