How the terra-luna crash has affected crypto trading
The value of the global cryptocurrency market plummeted by $1tn in May. What impact has this had on traders’ methods – and is there a way back for digital currencies?
In the second week of May, cryptocurrency enthusiasts around the world watched their screens in awe as the market collapsed before their eyes.
In tandem with the broader economic instability that had started during the final weeks of 2021, crypto values had generally been on a downward trajectory in any case. But their decline degenerated into a meltdown that reminded some traders of the beginning of the global financial crisis in late 2007.
The immediate cause was the implosion of terra – a so-called stablecoin, designed to reduce volatility in the crypto market by maintaining a fixed value over time. But, unlike other stablecoins, terra was not pegged to a stable reserve asset such as gold or the dollar. Instead, its stability was based on algorithms tied to its sister cryptocurrency, luna. When luna’s valuation plummeted from about $80 (£66) at the start of the month to a fraction of a cent, terra’s followed suit.
Their collapse sparked panic in the market. The price of bitcoin fell to $26,000, down 60% from its November 2021 peak, while ether, the next-biggest cryptocurrency, lost 30% of its value. Coinbase, one of the largest cryptocurrency exchanges, reported a loss of $430m in Q1.
Although the market has stabilised somewhat since the end of May, the valuations of many cryptocurrencies remain notably dented. Some key financial institutions, such as the International Monetary Fund, have cited the latest crash as proof – if any more were needed – of the inherent instability of this asset class.
Individual traders bear the brunt
There is an argument that the situation was far worse for individual traders than it was for large-scale investors. Aidan Mott, intel manager at crypto research provider Messari, agrees with this view, noting that such volatility has often resulted in a vigorous rebound for some currencies, particularly bitcoin and ether.
“It’s affected retail traders more than it has larger financial institutions,” he says. “Most people using Coinbase or Robinhood don’t have the access to the larger liquidity pools or other financial vehicles that large institutions do. The biggest volatility for bitcoin and ether has resulted in price increases, which is good for institutional traders. If you have an asset with zero volatility, there is no opportunity to make a profit. It doesn’t make sense as an investment.”
But choosing the right trading strategy for crypto is easier said than done. Consistency and quantifiability are at the heart of any successful approach. But, given the instability that comes with the territory, what can traders do to maximise their chances of making solid gains over the long term?
Edouard Hindi, chief investment officer at Tyr Capital, recommends that institutional investors adopt a bear-market attitude in light of May’s crash.
“Focus on the top 10 coins; don’t venture off,” he advises. “If you are more risk-averse, you could focus on bitcoin. The general idea runs along similar lines to the standard approach to allocating money during tougher times: focus on attracting yield and concentrate on cash-flow-positive names.”
Hindi continues: “What you typically do in this climate is move your money from altcoins to bitcoin. You will see the strength of bitcoin relative to the rest of the alt sphere.”
Professionalising crypto trading
Such tactics reflect the increasing professionalisation of cryptocurrency trading in recent years and the blurring of the boundaries between the traditional financial world and the crypto realm. Hindi expects this trend to continue, with more institutional investors using their expertise in risk management to profit from the instability of crypto markets.
This professionalisation could push retail investors – who’ve formed a sizeable proportion of crypto holders since bitcoin’s inception in 2009 – out of the picture. But such an outcome could serve to reduce volatility and encourage greater uptake by traditional financial players, according to Hindi.
“We’re going to see the players change. More institutions will step in, which will stabilise the market because they are less reactive,” he predicts. “They understand the risks and will be in it for the long term.”
Regulation is another way through which cryptocurrencies can regain the confidence of the professional trading community. Although this has long been mooted in the crypto world, discussions have yet to translate into action on any significant scale. But, less than a day after the terra-luna crash, the US treasury secretary, Janet Yellen, reaffirmed her desire to establish a regulatory framework. If she acts accordingly, she will have the support of President Biden, who in March had signalled his determination to bring some semblance of control to the market.
Dr Ying-Ying Hsieh is assistant professor of innovation and entrepreneurship at Imperial College London and associate director at its Centre for Cryptocurrency Research and Engineering. She believes that regulation will be a crucial enabler of wider cryptocurrency adoption, but is concerned about its potential for restricting innovation.
Although introducing a regulatory framework would require certain aspects of the crypto system to be centralised, Hsieh notes that its highly decentralised nature is a key part of what’s made the market so attractive to investors, both retail and institutional.
“Decentralisation is a continuum,” she says. “You could decentralise the network. You could decentralise the data. Or you could decentralise the ownership of the platform. It’s not a binary concept. But regulators need to consult the industry about what should and shouldn’t be decentralised. They must strike the right balance.”
Crypto is known to be risky, but traders like volatility. It gives them a chance to make money, particularly when they apply sophisticated trading strategies using powerful algorithms and other sophisticated tools.
And, as the crypto field gradually becomes more professionalised and controlled, it seems that May’s crash isn’t turning the pro trading community away. If anything, it’s doing the very opposite.