# Instability in Stablecoins By [linux_fan](https://paragraph.com/@linux-fan) · 2023-05-14 --- A stablecoin is a cryptocurrency for which the value is pegged to another currency, commodity, or financial instrument. Their main purpose is to be a refuge from the volatility in value of most coins in the crypto world. By the way, if you like reading about crypto, you should subscribe to this blog so you’ll be notified each time I publish another post! [Subscribe](null) After all, most reading this first learned about money in terms of fiat currency, such as US dollars. Everyday people don’t talk about the value of a dollar as it’s treated as a stable unit of value, although inflation and the level of demand for it in comparison to other currencies do, in fact, impact its value. So if one is trying to rely on the crypto scene for a fully decentralized finance experience, a stablecoin is (at least in theory) a good place to park funds which you don’t want exposed to risk of value fluctuations. But are stablecoins truly stable? I would say that depends on how they’re handled, and there are three ways to stabilize a stablecoin. The first is with fiat currency reserves, typically enforcing a 1:1 parity of held fiat to coin. The second is with crypto reserves, which seems counter-intuitive at first glance. How can one stabilize with something that is itself unstable? Crypto-backed stablecoins hold well over the value in their reserve base crypto as they issue in stablecoin. An example might be issuing only 50% of the reserve base value. So while this second type is still typically pegged to a fiat currency, that value is backed up by the crypto reserves. The third type of stablecoins are those based on algorithms which automatically manage the supply through a programmed formula. This is in some ways similar to how most central banks work, controlling money supply by either increasing or decreasing its rate of growth in order to stabilize the economy. The difference is that there’s no central authority or regulation at play here enforcing a stablecoin’s status as legal tender as there is for fiat currency. In 2018, Terraform Labs was founded by Do Kwon and launched the Terra stablecoin backed by an algorithm along with its related token named Luna. The way this algorithm worked was to automatically adjust the amounts of Terra and Luna in order to balance their supplies against each other. Since the goal was to keep the value of Terra tokens at $1, if the value of Terra fell traders would buy it and trade it for Luna to get a profit, while the algorithm would then reduce the amount of Terra and increase the amount of Luna accordingly to rebalance. Similarly, if the value of Terra rose, traders would buy Luna and trade it for Terra, prompting the algorithm to then increased the amount of Terra and decrease the amount of Luna accordingly. There was also in place a mechanism called the Anchor protocol. Anchor was a lending platform built on Terra’s blockchain offering significant rates of return on loans of Terra, creating significant demand for the token beyond transactions or holding for stable value. Then there was the Luna Foundation Guard, a sort of arrangement to stabilize Luna by exchanging Luna for Bitcoin. These Bitcoin holdings of the organization were meant to be a store of value to provide stability to Luna. The first few years were smooth sailing as by March 2022 Luna was at nearly $120 per token. But on May 2 of that year, Anchor announced a rate cut which evidently prompted a whale to exit on the exchange Curve Finance in two big withdraws totaling roughly $250 million. This triggered the crypto equivalent of a bank run, with many other Terra investors following in withdraws. The algorithm kept minting more Luna tokens to try to bring Terra’s price back up to $1, but this in turn dramatically drove down the value of Luna in a spiral of hyperinflation. The LFG started spending its Bitcoin reserves to try to rescue Luna, but it was already too late as trust in the system had been damaged. The prices of both Terra and Luna were decimated. At the time of this writing, Terra is at $0.015139 and Luna is at $0.000089. Next week will bring another stablecoins post about two which haven’t (so far) failed. Make sure you’re subscribed so you get notified when I publish new posts! [Subscribe](null) I have several plans for this blog which even expand beyond these posts, but I need funding to make it all happen. You can make a small contribution by linking a wallet to this platform (Mirror) and using the collect button to compensate me for my work. If you’d rather support me another way by setting the amount you’d like to contribute or in an alternative coin to ETH, I’d gladly accept donations of BAT, GRT, LINK, MATIC, SHIB, UNI, USDC, WBTC, AAVE, ENS, or WETH at the following wallet address. 0x0979109435E1c570E15A6c1bd939Cb2aBeB6eF28 ![QR code to scan with wallet app](https://storage.googleapis.com/papyrus_images/79827da6759c04cd77de1eac8b4b76ec814b039f2331f70b41d4d9f854a5fde4.png) QR code to scan with wallet app --- *Originally published on [linux_fan](https://paragraph.com/@linux-fan/instability-in-stablecoins)*