The past few weeks have been a dark time for digital currencies. Those familiar with the subject know that due to the Terra project, dark clouds have hovered over the world of cryptocurrencies. It’s time to answer the question of what really happened and why.
The case of the Terra project, even if it is already a few days old, still deserves to be discussed. I will try to explain in a simple way what really happened and show some dependencies in the world of cryptocurrencies. Initially, a small comparison, suppose that one day in the evening you put 1000 zlotys in a piggy bank, but the next day you would like to take them out. You break the piggy bank and there are 5 cents left of your thousand. Sounds abstract? – this is what happened to the savings of the owners of Luna. The chart below shows how the price of this coin has moved over the past month. The value of ~$80 turned into ~$0.00018 each. Simply put, when you invested ~ 350 PLN in the project, a moment later you were left with practically nothing.
Terra Luna is the perfect example of the volatility of the cryptocurrency market. Will the same thing happen to other projects? What about Ethereum and Bitcoin?
What is Terra Luna?
After such an unpleasant introduction, I might discourage a lot of cryptocurrency people, but take it easy, it’s time to explain what really happened. Many factors have contributed to such events, but let’s start with what Terra is. In 2018, the start-up Terraform Laboratories was created 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 a payment system for electronic commerce, so we can say that it would be something like a second PayPal. All based on blockchain technology, which in itself offered many advantages. The stability of the company as a financial system was to be ensured by the stablecoin – TerraUSD, the task of which was to reflect the value of traditional currencies. This seems logical, because imagine an e-commerce system dependent on fluctuations in the cryptocurrency market, which often reach even several tens of percent per day.
The project, however, was a bit more elaborate. The first distinguishing feature was its attitude towards the environment. Familiar with the subject of cryptocurrencies, they know that digital coins do not necessarily have a good effect on the ecology. Of course, it’s about the energy consumption when mining these currencies (you can read more about this in the our Ethereum overview). As a result, Terra, instead of hundreds of thousands of miners, only had 130 people in the network who authorized transactions and took care of project security. They were the holders of the highest amount of Luna Coins. However, this solution made the system more sensitive to certain manipulations. However, that’s not the only problem, so let’s move on.
It’s time to dispel doubts as to why two coins were really created – TerraUSD and Luna. The first, as I mentioned, was to be a stablecoin and maintain the level of $1 each, while Luna was supposed to get there. It is a slightly different system than other stablecoins, such as USDC, where each coin is backed by currency or gold. TerraUSD, or UST for short, was an algorithmic stabilization project. This is where Luna (LUNC) comes in, thanks to which you can properly “burn” the coins. When the UST price fell or moved below $1, the so-called arbiters created stabilizing trades. Simply put – when UST fell, they swapped them for LUNC, burning the traded tokens and thus reducing the supply, while UST rose, the reverse transaction was created.
Additionally, all system users, in order to buy a stablecoin such as UST, were forced to buy Luna, as TerraUSD could only be bought and sold through Luna. It sounds complicated, but the only thing you need to know is that in practice it was easy to use 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 everything was created, it’s time to introduce the next guest. We are talking about the Anchor Protocol, a financial instrument for creating loans and deposits with a very high interest rate of up to 20%.
Terra Luna – what happened?
Influencers entered the game, and the Anchor and Terra projects grew rapidly, attracting more and more investors. Everything seemed incredibly simple and anyone could join the network, guaranteeing themselves a high passive income. And it’s all based on Stablecoin, so what could go wrong? The fact that clients thought they were investing in a stable, immutable currency, not a typical cryptocurrency that could lose value in an instant. Everything seemed safe, but not everyone was aware that the stablecoin had no real coverage in traditional payment methods.
So you can guess – as long as the Terra project has capital, everything works. But when the investors’ money is gone, the whole system could simply collapse. And that’s how the problems started. It turned out that no one was willing to borrow, so investors’ high-interest deposits yielded nothing. In February of this year, the creators decided to support the Anchor project and financed it with capital in the amount of 450 million dollars in order to secure profits on investments. Few noticed the company’s problems, slowly walking away with their money. However, a large part of the community still saw it as a good form of investment, happy that the creators additionally supported the project with such large capital.
Although the whole Terra project from the very beginning did not have a very solid foundation in the form of securing capital, the positive story of the creators and wide publicity (also in Poland) brought the company many enthusiasts. However, not everyone received information about how the system really works. It is unfortunate that the deterioration of the situation in the world market, as well as the coordinated attack on the UST, showed the weaknesses of the company. As a result, the TerraUSD arbitrage project got slightly overloaded, the price stabilization system failed, and the coin value fell well below $1. Of course, this was noticed by the rest of the clients who, fearing for their capital, were massively withdrawing their savings, which led to even greater declines. In this way, the market fell from the value counted in billions to only a few tens of millions, and Luna lost almost 100% of its value.
Terra Luna – what next?
Such an event has widely echoed in the world of cryptocurrencies and more. So let’s start with the fact that the coins have lost confidence. In the end, in about ten hours, the project, which occupied the 10th place in terms of size of all projects related to digital currencies, collapsed. This indirectly shook even such giants as Bitcoin, whose value fell below $30,000. You have to remember that although individual cryptocurrencies are not directly related to each other, the whole industry is somewhat dependent on each other. Of course, the situation has also caught the attention of regulators in the financial services industry. Moments after this event The U.S. Treasury Department Announced Work on Stablecoin Law Regulations. The case is also being followed by agents of the Economic and Monetary Committee. It can therefore be expected that unstable stablecoins will soon be subject to restrictions that will ensure 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. Although the creators have announced work on rebuilding the Terra project, it may just be impossible. Support was offered by the largest cryptocurrency exchange – Binance, which is to support the Luna 2.0 project, and specifically to carry out the so-called airdrop (distributing free cryptocurrencies) for its users. The plans are extensive and in theory aim to return the project to its original market value. The problem, however, may be user reception. Eventually, many lost faith in Terra, and some even lost faith in the crypto industry as a whole. You can come across very critical opinions online. However, there are enthusiasts who believe in rebuilding – presumably their estates were swallowed up by Luna and they just want them back.
Terra Luna – what now?
The TerraUSD and Luna cryptocurrencies could be successfully traded on the previously mentioned Binance, but at present, trading opportunities have been blocked. There’s no definitive answer to whether Project Terra will get back on its feet, let alone whether Luna will return to ~$80 each. The creators themselves inform about upcoming plans and events on Twitter. The question is whether there is a chance that the activities carried out will produce the desired effect?
When investing in cryptocurrency projects, it helps to know how they actually work. Remember that all information can be found in the individual part descriptions. Digital currencies are often correlated with very complex and ambitious projects, even if this does not always mean a good financial investment. Each coin has different assumptions, a good example of which is the aforementioned Ethereum. In this industry, however, there is no shortage of very experimental projects or simply rip-offs. So, if you want to invest in cryptocurrency, it is worth doing it with caution and, most importantly, following the principle – “I will spend as much money as I can lose”. Of course, this also translates into somewhat less turbulent traditional forms of investing.
What is NFT?
In order to defend digital currencies, I would like to add that in the past the market also went through difficult times, and yet it was still recovering successfully. An example of a very uninteresting situation was, for example, 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 have been with us for a relatively short time, so events like this certainly attract more attention. However, it is worth learning from these examples and analyzing them accordingly, thus eliminating the possibility of unfavorable investments in the future. In conclusion, I would like to add that the collapse of Luna, although huge, is not a threat to other digital currencies with solid foundations. Do you think Luna has a chance to come back and restore trust? Write in the comments.
Author: Patryk Pawelak