The past few weeks have been a dark time for digital currencies. Those familiar with the subject know that because of the Terra project, black clouds have hung over the world of cryptocurrencies. It’s time to answer the question of what really happened and why.
The case of the Terra project, although it is a few days old, is still worth discussing. I will try to explain in a simple way what really happened and show some dependencies in the world of cryptocurrencies. A little comparison at the beginning, let’s assume that one day you put 1000 zloty in a piggy bank in the evening, but a day later you would like to take them out. You break the piggy bank and 5 cents remain of your thousand. Sound abstract? – that’s what happened to Luna owners’ savings. The chart below shows how the price of this coin has developed over the past month. The value of ~$80 became ~$0.00018 each. Simply put, once you invested ~350 PLN in the project, moments later you were left with practically nothing.
Terra Luna is the perfect example of how volatile the cryptocurrency market can be. Will the same happen with other projects? What about Ethereum and Bitcoin?
What is Terra Luna?
After such an unpleasant introduction, I could discourage many people from cryptocurrencies, but take it easy, it’s time to explain what really happened. Many factors contributed to such events, but let’s start with what Terra is. In 2018, the start-up Terraform Laboratories was founded in South Korea. A year later, the Asian company also launched its digital currencies – Luna and TerraUSD. The idea of creating them was to launch an e-commerce payment system, so you can say it would be something like a second PayPal. All based on blockchain technology, which in itself brought many benefits. The stability of the company as a financial system was to be ensured by the stablecoin – TerraUSD, whose job was to reflect the value of traditional currencies. It seems logical because imagine an e-commerce system that relies on fluctuations in the cryptocurrency market, often reaching even tens of percents per day.
However, the project was slightly more extensive. The first distinguishing feature was the attitude to the environment. They are familiar with the topic of cryptocurrencies and know that digital currencies do not necessarily have a good effect on the ecology. It is of course about the energy consumption when mining this currency (you can read more about it in the our Ethereum overview† Therefore, instead of hundreds of thousands of miners, Terra had only 130 people in the network who authorized the transactions and ensured the security of the project. They were the holders of the largest number of Luna coins. However, this solution made the system more sensitive to certain manipulations. However, this is not the only problem, so let’s move on.
It’s time to clear up any doubts about why two coins were really created – TerraUSD and Luna. The first, as I mentioned, was to be a stablecoin and hold the $1 each level while Luna had to make it happen. This is a slightly different system than other stablecoins, such as USDC, where each coin is backed by a currency or gold. TerraUSD, or UST for short, was an algorithmic stabilization project. This is where Luna (LUNC) comes into play, which should do a good job of “burning” coins. When the UST price fell or rose below $1, the so-called arbitrators created stabilizing trades. Simply put – when UST fell, they traded them for LUNC, burning the exchanged tokens and thus reducing the supply, while UST grew, the reverse trade was created.
Moreover, to buy a stablecoin like UST, all system users were forced to buy Luna because TerraUSD could only be bought and sold through Luna. It sounds complicated, but all you need to know is that it was easy to use in practice and the stablecoin was not permanently pegged to the US dollar. This is where the real fun begins. Now that you know what Terra, Luna is and why and on what basis it was all made, it’s time to introduce the next guest. We are talking about the Anchor protocol, which is a financial instrument for creating loans and deposits with a really high interest rate of up to 20 percent.
Terra Luna – what happened?
Influencers came into play and the Anchor and Terra projects grew rapidly and attracted more and more investors. Everything seemed incredibly simple and basically anyone could join the network and ensure themselves a high passive income. And it’s all stablecoin based, so what could go wrong? The fact that customers thought they were investing in a stable, non-changing currency, not a typical cryptocurrency that could lose value in the blink of an eye. Everything seemed safe, but not everyone was aware that stablecoin had no actual backing in traditional payment methods.
So you can guess – as long as the Terra project has capital, everything works. But if the investors’ money ran out, the whole system could just collapse. And so the problems started. As it turned out, there were no people willing to borrow, so investors’ high-interest deposits weren’t making any money. In February of this year, the makers decided to support the Anchor project and financed it with a capital of $450 million to secure the return on investment. Few noticed the company’s problems and slowly walked away with their money. However, a large part of the community still saw a good form of investment here, happy that the makers are also supporting the project with such large capital.
Although the entire Terra project did not have a very solid foundation from the start in terms of securing capital, the positive story of the creators and wide advertising (also in Poland) brought the company many enthusiasts. However, not everyone received information about how the system works. It was unfortunate that the deteriorating world market situation, as well as the coordinated attack on the UST, showed the company’s weaknesses. As a result, the TerraUSD arbitration project was somewhat overloaded, the price stabilization system failed and the coin value dropped well below $1. This was of course noticed by the rest of the clients who, fearing for their capital, went into massive withdrawals of their savings, and this led to even greater declines. In this way, the market dropped from its value in billions to just a few tens of millions, and Luna lost almost 100% of its value.
Terra Luna – Now What?
Such an event reverberated widely in the world of cryptocurrencies and beyond. So let’s start with the fact that coins have lost confidence. Finally, within a dozen hours, the project, which ranked 10th in terms of size of all projects related to digital currency, collapsed. This indirectly even shocked giants like Bitcoin, whose value fell below $30,000. You must remember that while individual cryptocurrencies are not directly related to each other, the entire industry is somewhat interdependent. Naturally, the situation has also attracted the attention of regulators in the financial services industry. Moments after this event US Treasury Department has announced work to regulate stablecoin law† The case is also being followed by members of the Economic and Monetary Committee. It is therefore expected that unstable stablecoins will soon be subject to restrictions that will guarantee their 100% stability.
Unfortunately, although I am personally excited about the world of cryptocurrencies, such situations deeply show that this industry still has a lot of holes. While the creators have announced that the Terra project reconstruction is underway, it may just be impossible. Support was provided by the largest cryptocurrency exchange – Binance, which is supposed to support the Luna 2.0 project, and more specifically to provide the so-called airdrop (distribution of free cryptocurrencies) for its users. The plans are extensive and in theory should ensure that the project returns to its original market value. However, the problem may be user reception. In the end, many lost faith in Terra and some even lost faith in the crypto industry as a whole. Online you come across very critical opinions. However, there are enthusiasts who believe in rebuilding – it can be speculated that their estates have been swallowed up by Luna and just want them back.
Terra Luna – Now What?
The TerraUSD and Luna cryptocurrencies could be successfully exchanged on the aforementioned Binance, but at the moment the transaction possibilities are blocked. There is no definitive answer as to whether the Terra project will stand up, let alone whether Luna will return to ~$80 each. The makers themselves inform about plans and upcoming events on Twitter. The question is whether there is a chance that the activities carried out will have the intended effect.
When investing in cryptocurrency projects, it is worth knowing how they really work. Remember that all information can be found in the descriptions of individual coins. Digital currencies often correlate with very complex and ambitious projects, although this does not always mean a good financial investment. Every coin has different assumptions, a good example of this is the aforementioned Ethereum. However, in this industry there is no shortage of highly experimental projects or just plain scams. So if you want to invest in cryptocurrency, it is worth doing it carefully and above all following the principle “I will spend as much money as I can lose”. Of course, this also translates into slightly less turbulent, traditional forms of investment.
What is NFT?
To defend digital currencies, I would add that the market had bad times in the past as well, yet was successfully recovering. An example of a very uninteresting situation was the collapse of the largest stock exchange MTGox in 2014. It should also not be forgotten that spectacular bankruptcies also occur on the traditional stock exchange. Cryptocurrencies are relatively short with us, so such events certainly attract more attention. However, it is worth learning from such examples and analyzing them accordingly, eliminating the possibility of unfavorable investments in the future. Finally, I would like to add that the collapse of Luna, while massive, poses no threat to other digital currencies with solid foundations. Do you think Luna has a chance to come back and restore confidence? Write in the comments.
Author: Patryk Pawelak