What Happened With LUNA/TERRA & Why It Matters for the Rest of Crypto | Carthago
The Implications are Real
Learning Objectives
- Terra/Luna as an altcoin was backing the stability of a stablecoin — UST.
- TerraUSD (UST) lost it’s $1 value after its algorithm failed to adjust for supply/demand.
- Luna’s crash will result in huge implications for altcoins and the perception of cryptocurrencies.
Before Cryptocurrency hit the mainstream spotlight, in 2017 there was a coin with a high-yield investment program called Bitconnect (BCC). A bitter memory or a meme to some, Bitconnect was suspected of being a ponzi scheme for its suspiciously high payouts, boasting a 1% daily compounding interest. New investors would buy into BCC through trading in their Bitcoin. Bitconnect’s value was tied to the value of volatility of Bitcoin. Bitconnect’s initial coin offering was $.17 in 2016 and saw an all time high of over $450. After news broke out that the founders of Bitconnect were failing to repay its investors due to its Ponzi Scheme structure, the price of BCC collapsed. After multiple cease and desist letters, and failing to prove its legitimacy, the company met its demise and defrauded its investors out of 2.2 Billion.
We mention this brief history lesson, because the current events of Terra (UST) and Luna (LUNA) collapsing might come as a shock to new members in the crypto space. Stablecoins such as Terra are pegged to the price of the U.S dollar, which allows traders and investors to buy/sell their crypto without undergoing volatile changes in price action. Stablecoins still retain the qualities of cryptocurrencies, and remain decentralized by nature. This allows investors to preserve their fiat value without cashing out of the market completely. Many traders even opt to hold their net worths in stablecoins during periods of market decline. Another advantage of stablecoins is the opportunity to receive high APY (annual percentage yield) returns for holding stablecoins. The reasoning behind the high interest returns on holding stablecoins is to compensate investors for the risk that the stablecoin will fall off its peg.
Stablecoins are seen as a safe and secure investment in crypto, and a great alternative to risk-averse investors. While the U.S dollar offers relatively low interest rates, and banks find no reason to pay interest for holding U.S currency, the reverse can be said for stablecoins. The demand for stablecoins constantly exceeds supply. So people who have stablecoins to lend can charge premium interest rates, and crypto platforms desperate for stablecoins offer high interest rates to attract new stablecoin lenders.
Because the Federal Reserve controls how much U.S dollars are printed in circulation, the opposite can be said for stablecoins. Stablecoins are not backed by any asset, and can be created from thin air in order to meet demand. After all, there are no limits on a stablecoin’s issuance, and are being minted at extraordinary rates.
In the case of UST, it yields a whopping 19.53% APY, which has proved to be unsustainable after recent events. UST has plummeted along with its sister coin Luna with no end in sight. Many people have suffered great losses because of this decline. Alt-Coin Luna has just seen an all time high last month of $119.18, and is trading for less than $1 at the time of publishing. This isn’t the first time we have seen a stablecoin depegging from the dollar, Neutrino (USDN) which is built on top of the WAVES blockchain faced a similar fiasco in April of this year, where we saw the price drop to $.80 due to speculation of shorting and price manipulation. These current events will lead to an overall loss of confidence in the stablecoin realm.
What Happened?
On Monday, May 9th Terra/Luna and its associated stablecoin TerraUSD lost over 80% of its value in just a span of ~10 hours. The significance of the value loss sent shockwaves throughout crypto markets which led to even further panic selloffs and trades. What exactly caused the value depreciation of Luna’s asset?
Terra/Luna is tied to UST (TerraUSD), a stablecoin that is backed by the Luna asset. UST is an algorithmic token which means that tokens are minted or burned off automatically to account for demand. In theory this helps maintain the $1 UST is equal to $1 USD relationship. However, after large holders of the asset sold off millions over the weekend the algorithm failed to account for the change and the value plummeted to $0.60.
The Luna Foundation Guard attempted to stabilize Luna by offering $1.5 billion in loans (attempting to acquire real cash by offering temporary money that would be returned with interest), but the market did not respond positively and the value of UST fell further to $0.30.
Since LUNA is the backer of UST, its value also fell drastically in response to the crash of UST. Despite low values, many people continue to panic sell Luna and UST, which will likely continue to cause the value of the assets to drop. Couple that with an overall fear of the crypto market now, and it is even more unlikely that LUNA will see a recovery.
Why It Matters?
Stablecoins have been praised as the non-volatile and secure option for the cryptocurrency world. Users could safely keep their fiat money in a stablecoin and not awake the following morning with a huge loss. USTs drop in value has shown that stablecoins are not really all that stable — especially when their value is not truly backed by real world assets.
USTs crash has mostly unforeseen circumstances on the future use of stablecoins, crypto, and deFi as a whole. First of all, trust in stablecoins will likely decline greatly and it can be expected that a mass selloff of stablecoins will occur in the near future (at least those which do not have proper auditing and security protocols in place). Second, many companies that allowed crypto payments using stablecoins will likely rethink their positions. After all, if a stablecoin can lose its value it’s no good in day to day transactions — businesses would go bankrupt overnight. Lastly, it calls into question the true function of a stablecoin. If it’s not a safe asset then what is it and why do we need them or how do we use them?
Future Implications
- Cryptocurrency values further decline as a result of panic from the selloff.
- Financial institutions will re-analyze their use of stablecoins in current operations.
- Government review and regulation becomes more strict to protect consumers of cryptocurrencies.
- Stablecoins lose favor amongst cryptocurrency investors.
- Web3’s reputation is likely damaged as a result of the crash — creating distrust of the system as a whole.
- The collapse of Bitconnect happened right before the 2018 Bitcoin crash, leading to a 3 year bear market. History has a strange way of repeating itself.
- Bitcoin and Ethereum will be viewed as the only reliable cryptocurrencies in years to come due to their stability while the hype around altcoin will sink.
Summary (TL:DR)
Since the dawn of their existence, stablecoins have been seen as a safe and reliable asset pegged to the value of the USD, with high interest returns, and an ideal alternative for risk-averse investors. And for the high-risk traders in the crypto market, it has been a safe haven for buying and selling crypto without risk of volatile price action.
To kick off the 2022 Bear Market, investors and traders alike have witnessed the price of $Luna and $UST free fall. $LUNA, after reaching an all time high of $119.18 last month is now worth less than $1 with TerraUSD not falling too far behind. This has caused a lot of fear and uncertainty within the world of stablecoins, and is beginning to stir up noise of harsher government regulations. Do Kwon, the CEO and Founder of the Terra protocol has responded with an attempt to stabilize the coin by deploying 1.5 billion in reserve currency. The market however, did not respond well to this and led to another crash, with UST currently priced at $0.69 at the time of this publishing.
Only time will tell the effects this will have on the blockchain space, crypto and DeFi as a whole. Perhaps it will be seen as a bitter memory or meme like Bitconnect, or it will be a catalyst for investigating deeper into the functionalities of stablecoins.
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