Learning from Luna and Why Crypto Still Has Potential
Now that the week has come to a close after experiencing some of the greatest volatility in the cryptocurrency market in a long time, what we can we learn about how other crypto assets (non-LUNA) have fared?
Many people have already done a great job explaining what’s happened with LUNA and the stablecoin market (see Rabinder Kumar’s article here, Sarah Wiesner’s article here, and Lambis Dionysopoulos’s article here): in brief, diminished trust in Terra’s ability to maintain the peg and the sustainability of the Anchor Protocol led to an exodus of investment.
In economics, these are often called “fire sales” and frequently happen in local housing markets when investors get scared and sell off assets in bulk. (My research has explored the effects of such fire sales on individuals.)
But there is a lot of confusion about how other crypto assets have been affected and whether crypto is still “safe.”
Context — Other Crypto Assets
Building on newly-licensed data from Refinitiv’s MarketPsych that we began to share last week, it is useful to look at economic sentiment as an indicator for beliefs about an asset and the likely price dynamics.
While there is no a single definition of sentiment, it broadly refers to beliefs about an asset. Those beliefs can be about the future state of an asset (or the economy), or they can be about a current state. Refinitiv’s MarketPsych model produces an index of sentiment for each day and across asset classes.
The index is constructed by feeding every news article and social media through their natural language processing (NLP) algorithms, tagging words and phrases as high or low sentiment. They also disaggregate across different types of sentiment, including trust, uncertainty, urgency, and more.
The figure below examines sentiment across news articles and social media for Bitcoin, Ethereum, and Terra since March 2022. We see a substantial decline in sentiment about Terra over the past week, but not nearly as big of a drop off for BTC and ETH. In fact, there is some evidence of a slight recovery, but time will tell and we’ll see how long it takes.
We see a substantial decline in sentiment about Terra over the past week, but not nearly as big of a drop off for BTC and ETH.
We can also look at other measures of economic attitudes, like uncertainty. We see, for example, that uncertainty spiked for Terra much more than for BTC or ETH. While the decline in uncertainty in more recent days might seem counterintuitive since Terra is still doing poorly, it just reflects greater clarity among the public that it’s not doing well (and may not recover).
Similarly, we can look at attitudes about each asset’s future, relative to its past. Again, we see substantially worse index values for Terra, relative to BTC or ETH, especially over the more recent days.
To be clear, sentiment across other stable coins has been affected too since the whole experience raises the possibility of “unknown unknowns” — that is, rare events that we are not even sure how to model or express. The figure below shows that sentiment for Tether and USDC also declined, although it appears to be recovering for them (and not for Terra).
The experience with Terra teaches us the importance to cut through the hype and look at fundamentals. If a project cannot explain answers to basic questions — like how high returns can be achieved indefinitely — then maybe there’s a problem that most people simply haven’t caught on to.
But that should not cause us to throw the baby out with the bath water. Many crypto assets still have incredible potential and the beauty behind BTC and ETH, for example, is that they have a tested and clear value proposition.
Ethereum, in particular, has incredible value: its an entire ecosystem that people are building off daily. If there were serious reservations about its future, then you would have a lot less developers building off it and staking their own time and money.
Let’s keep learning and scrutinizing the opportunities — many still reside on the horizon and there’s much to learn about the Terra experience!
This article was written by Christos A. Makridis, the Chief Technology Officer and Head of Research at Living Opera. He is also a research affiliate at Stanford University’s Digital Economy Lab and Columbia Business School’s Chazen Institute, and holds dual doctorates in economics and management science & engineering from Stanford University. Follow us at @living_opera! (This is not financial advice!) Thank you to Refinitiv/MarketPsych for their data!