How the terra-luna crash has affected crypto trading

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.