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A "Black Swan" incident is unanticipated beyond what is generally expected of a scenario, is clear in hindsight, and could have serious repercussions. The subprime crisis and subsequent collapse of the financial sector in 2008 and the market surrender that followed the onset of the global pandemic are examples.

Black Swan incidents are generally seen as undesirable in the financial markets or any other industry. Nonetheless, history demonstrates that these occurrences are also a turning moment for systemic improvement. I suppose this incident will follow the same procedure.

The failure of UST as an algorithmic stablecoin is a Black Swan event that never should have occurred. It was a project valued more than $18 billion, making it virtually impossible to fail. Long ago, the crisis could have been prevented if the project's automated trading mechanism had been subject to more stringent regulatory oversight.

The bitcoin price dropped by $10,000 in a matter of hours as the Terra crisis spread to it. It has also caused extensive harm to our crypto industry peers, particularly exchanges and small and large investors.

If automated decentralized finance (DeFi) trading systems are to reach this magnitude, more regulation and stakeholder protections are required.

Threats posed by algorithmic stablecoins

This week, the hazards linked with algorithmic stablecoins have gained prominence. The primary takeaway is that computer code cannot substitute collateral backed by assets.

Instead than being backed by assets, an algorithmic stablecoin is stabilized by computer code using an algorithm or algorithms designed to maintain its peg. Numerous "algos" have failed before UST, but this historic failure demonstrates that algorithmic stablecoins have architectural flaws.

Unfortunately, this design flaw in the Terra network has brought a multibillion-dollar enterprise to the brink of collapse within days. It also posed a systemic risk for DeFi and the entire cryptocurrency sector.

The network's developers, especially Terraform Labs, attempted to defend the UST/USD peg by selling substantial reserves of BTC.

A silver lining: it appears that asset-backed stablecoins such as USDT, USDC, and BUSD have withstood the storm, and market sentiment has remained stable. On Thursday, USDT traded roughly 5% away from its USD peg, demonstrating how severe volatility affects the price of stablecoins that are intended to be fully backed by assets.

This event has highlighted important lessons for the DeFi sector to absorb: Algorithmic stablecoins are either ineffective or require extensive additional research and development. In addition, regulatory and technological constraints must be implemented before another algorithm may grow to this size.

Cryptocurrency must be able to withstand high volatility

This is not the first nor the last Black Swan incident. They will occur once more in the future. The crucial point, however, is why there was systemic impact that affected other market assets and how this may be averted.

The answer hinges on liquidity, volatility, and how markets react to Black Swan events. The crypto markets are thinly traded and lack liquidity. Liquidity is compartmentalized and crypto markets are highly inefficient. Even the most stable cryptocurrencies, such as Bitcoin and Ethereum, become especially susceptible. All assets will decline in value if liquidity cannot flow.

Consequently, crypto markets require liquidity aggregators. These technologies could assist investors in navigating the choppy waters generated by Black Swan events - when volatile conditions develop, market participants must have access to liquidity at the lowest feasible cost to maintain equilibrium.

Regarding regulatory controls, I am confident that legislators will examine the implosion of one of the largest crypto assets in history and devise means to rein in the business.

This is only our industry evolving and developing.

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