Terra Money, what happened with a top 10 crypto project?
About a year ago (May 09, 2022) one of the projects which had good adoption and growth during the Bull Market started in 2021 was TERRA (Better known as LUNA). This project had many products within its ecosystem and one of its main focuses was the Decentralization of money, so it started with Stablecoins.
Stablecoins are intended to always maintain parity to the U.S. dollar in the volatile Crypto market. Before TERRA’s proposal, there were already custodial (CIRCLE) and non-custodial (DAI) Stablecoins but these were backed by FIAT currency, which is why UST was launched which
was not backed by dollars but by the other crypto he created called LUNA.
The system was based on the typical supply and demand, when UST moved above its parity of 1 dollar, anyone could exchange LUNA for UST and sell it for a profit which would increase the supply of UST and return the price back to 1. On the contrary, when UST went below its parity of 1 dollar, people could exchange UST back to LUNA which would decrease the UST in circulation and return the parity to 1 dollar.
In addition to this, in early 2022 a mechanism was created where Bitcoin was used as a backup in case the parity was lost. Basically now if the parity were lost, the same mechanism mentioned above was continued but now people were encouraged to exchange their UST for BTC (where 1UST = .98 BTC, which represented buying BTC cheaper. What this did was reduce the supply of UST. If it would otherwise go up, they would be encouraged to sell their BTC to get UST in exchange for it.
The problem with this type of Stablecoin is that it needed to attract demand and movement of both assets so it was necessary to build services and products to support this, i.e., that it was backed by a real economy as it would help people to decide which one to acquire (LUNA or UST).
Before integrating BTC as a backup for their Stablecoin, they realized that if HOLDERS started selling and both prices started going down, people would not want to exchange their UST for LUNA or vice versa and what would happen is that money would leave the TERRA ecosystem, better known as a death spiral or bankruptcy. For this, they introduced Chai which allowed people to buy real-life things using UST, then Anchor which gave them a 20% return for staking their UST, this made almost 80% of the UST in circulation tied to Anchor.
What happened with this high yield was that it was not sustainable considering the interest rate on the loans they were charging and little by little Anchor’s reserves were depleted which made TERRA invest money in this so that it would not collapse.
However on May 9th given certain UST movements noticed by major players, UST lost parity to .9 USD, this caused large positions to be opened in SHORT of LUNA, and from there the death spiral began followed by LUNA as in trying to maintain UST parity it began to print LUNA infinitely.
The Bitcoin reserve failed since they did not consider the adverse situation where the Bitcoin price could fall abruptly and this would cause
the reserves they had to avoid the death spiral to be insufficient.
60BN of market cap was reduced to nothing in the blink of an eye.
In my opinion, LUNA was a promising project that had a good ecosystem behind it and quite a few applications using their coin. However, what can be learned is that:
- Always consider your worst-case scenario… What would happen if you happen this or that? Consider that the most unexpected things can happen.
- Don’t get overconfident. Always evaluate market possibilities and study market history so you don’t repeat it.
- Monitor closely what is happening in your projects and the sentiment of it.
- Be wary of those who promise you excessive ROI, they are not sustainable.
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