Terra and Luna’s crypto crash: What happened and its relevance

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Currently, the bitcoin market is not a safe haven; warnings may be found in every direction. Bitcoin and Ethereum, or ether for short, have reached their lowest levels since 2020, with alternative coins, or altcoins, such as dogecoin and Cardano faring considerably worse.اضافة اعلان

While the drop is distressing for crypto investors, it is not unusual as cryptocurrencies are notorious for their volatility, and volatile economic conditions are pulling down crypto and the stock market.

About two weeks ago, Luna cryptocurrency and its accompanying terraUSD stablecoin, dubbed UST, had an unprecedented crash. Billions of dollars in cryptocurrency riches have vanished, sending shockwaves across the market.

There are two connected tales here: the UST stablecoin and Luna’s, both of which are part of the terra blockchain. The UST coin is always meant to have a value of $1, but it was depegged on May 9 and has since dropped to barely 13 cents. Then there’s Luna, the ecosystem’s focal point. Its value has plummeted in one of the most spectacular crypto collapses ever witnessed.

The value of the coin has dropped from $116 in April to a fraction of a penny at the time of writing. Such a crash has already occurred in small-cap memecoins, but never for a currency the scale of Luna, which had a market valuation of more than $40 billion just last month.

Here’s everything you need to know about the wipeout.

What exactly is a stablecoin?

To grasp the crypto disaster, you must first understand what a stablecoin is. In essence, it is a cryptocurrency linked to a more stable currency. The most popular of them are tether and USDC, which, like other stablecoins, are “tethered” to the US dollar. So, if you have 1,000 USDC tokens, you may trade them for $1,000 at any moment.

Stablecoins are essential components of “DeFi,” or decentralized finance, and are intended to help investors hedge against the cryptocurrency market’s volatility. Assume the price of ether is $2,000; a trader might swap one ether for 2,000 USDC tokens. If ether falls 50 percent to $1,000 tomorrow, the 2,000 USDC tokens are still worth $2,000 and can be exchanged for two ether tokens.

When investors anticipate a downturn, they place their bets on stablecoins like as tether, USDC, and UST until this week.

The terra/UST coin differs from tether and USDC in one important way: it is not backed by actual US dollars but rather is an algorithmic stablecoin. The concept is that the UST’s dollar peg can be maintained without needing to be backed by the dollar via a few smart techniques and billions in bitcoin reserves.

The holy grail of DeFi is a decentralized stablecoin. The benefit of Bitcoin and ether is that they are difficult to regulate for bureaucrats, politicians, and central bankers, but their disadvantage is price volatility.

What are Terra, Luna, and UST?

Terra, like Ethereum and Bitcoin, is a blockchain. While the Ethereum network creates ether tokens naturally, Terra’s blockchain produces Luna tokens natively.

You must burn Luna to make UST. For example, last week, you could exchange one Luna token for 85 UST (since the Luna was valued at $85), but the Luna would be destroyed (“burned”) in the process. This deflationary technique was designed to safeguard the long-term growth of the Luna. As more individuals invest in UST, more Luna will be burnt, increasing the value of the remaining Luna supply.

To attract traders to burn Luna to generate UST, the Anchor Protocol provided a ridiculous 19.5 percent yield on staking — which is effectively crypto slang for earning 19.5 percent interest on a loan. Instead of putting your money in a bank for a 0.06 percent interest rate, the pitch is to put it in UST, where it may yield over 20 percent.

Before depegging, this scheme held over 70 percent of UST’s circulating supply, or over $14 billion.

The key to UST holding its peg is as follows: One UST may always be traded for one Luna. So, if UST falls to 99 cents, traders might benefit by purchasing a large quantity of UST and trading it for Luna, earning one cent each token. The impact operates in two ways: people buying UST raises the price, and UST consumed during its conversion to Luna deflates the supply.

The reserves come next. Do Kwon, the founder and CEO of Terraform Labs, established the Luna Foundation Guard (LFG), a coalition tasked with protecting the peg.

LFG had around $2.3 billion in bitcoin reserves, aiming to increase this to $10 billion in bitcoin and other digital assets. If UST fell below $1, bitcoin reserves would be liquidated and the money used to purchase UST. If UST rises over $1, creators will sell UST until it returns to $1, with the proceeds used to buy additional bitcoin to replenish reserves.

Everything makes sense. However, knowing all of this — how did it crash so hard?

The crash

It all began on Saturday, May 7, with over $2 billion of UST unstacked (taken out of the Anchor Protocol) and instantly sold for hundreds of millions of dollars.

It’s unclear if this was a reaction to a particularly tumultuous moment (the rise in interest rates has had a particular impact on cryptocurrency values) or a more deliberate attack on Terra’s infrastructure.

Such massive sales drove the price down to 91 cents. Traders attempted arbitrage by swapping 90 cents worth of UST for $1 worth of Luna, but a speed bump emerged. Only $100 million of UST can be burnt every day for Luna.

Investors, already jittery in the current bear market, hurried to sell their UST after the stablecoin failed to maintain its peg. It fluctuated between 30 cents and 50 cents in the week following the first depeg, but it has since dropped to less than 20 cents. Its market capitalization has fallen from roughly $18 billion in early May to $2 billion currently.

It’s much worse for Luna owners. The value of Luna tokens has nearly vanished: after peaking at just under $120 in April, the current price is less than a fiftieth of a penny.

Concerning the potential of a malicious assault, some believe an attacker attempted to breach UST to benefit from shorting bitcoin, or speculating on its price falling. If potential attackers established a significant position in UST and then unstacked $2 billion all at once, it might depeg UST, requiring Terra’s staff to sell sections of its bitcoin reserve to repeg the stablecoin.

When investors realized that UST had lost its peg, they would hurry to unstack and sell their UST, requiring additional bitcoin reserves to be liquidated, adding to the selling pressure.

What difference does it make?

This is significant for three reasons.

First, almost $15 billion in crypto value has been wiped off by Luna and UST alone. The implied financial damage that this fact alone brings to Luna, and the crypto ecosystem as a whole is massive.

Second, it calls into doubt other stablecoins. UST was unique in that it was an algorithmic stablecoin instead of tether and USDC.

Boroughs are concerned that if UST is targeted, similar moves will be taken against the others.

There are concerns online over what happened to UST; could it spread to other stablecoins? If huge whales discovered a script that works to attack UST here, there is much to be concerned about — attackers could utilize that playbook in other market sectors.

Third, and perhaps most importantly, the fall of UST has piqued the interest of prominent politicians and authorities. On Tuesday, US Treasury Secretary Janet Yellen stated that UST’s depegging underscores that stablecoins are rapidly increasing products with rapidly growing dangers.

What does this mean for you?

Always look into what you’re investing.

Due diligence is at an all-time low, with the average retail investor throwing money into crypto simply because it’s chic.

Read whitepapers; learn about the ecosystem, and browse forums that offer actual advice and not “Ponzinomics” sales pitches. At the end of the day, while not a novel idea, cryptocurrencies are still relatively new in the market in terms of actual use cases — and this ecosystem is rife with scam projects, meme-coins, and dev teams that have not produced anything feasible over years of development.

Always remember: whatever you put into crypto, always assume that all of it is lost upon purchase; never put in more than you are willing to part with.

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