Is it over for Terra-Luna? Here’s What You Should Know About the Crash

July 16, 2022

The intense collapse of LUNA and UST has definitely ruined not just the reputation of Terra-Luna’s team, but also the cryptocurrency market in general. 

With its 60 billion-dollar market cap hitting rock bottom in an instant, FUD (Fear, Uncertainty, and Doubt) was spewn all over the place, bringing panic and selling pressure across the crypto market as people began to realize the inherent risks with decentralized stablecoins.

Here’s a quick rundown on what happened to LUNA and UST:

  • UST or US Terra, the Terra-Luna ecosystem’s stablecoin, relies on an algorithm tied to its base token, LUNA, to stably maintain its $1 peg. This is unlike USDT, USDC, or BUSD, which are backed by US Dollar reserves and audited by the government.

  • The algorithm works this way: 1 UST can always be swapped for $1 worth of LUNA, and vice versa. When either of them is exchanged, both tokens' supplies adjust respectively.

  • For example, when Gab swaps 1 UST for $1 worth of LUNA, UST is burned, and new LUNA is minted.

  • Accordingly, when Gab swaps $1 worth of LUNA for 1 UST, LUNA is burned, and new UST is minted.

  • Theoretically, a decrease in supply means a higher price, and an increase in supply means a lower price.

LUNA and UST’s algorithm from Cointelegraph
  • This relationship between UST and LUNA helps keep UST's price pegged at $1. Let's say UST’s price goes to $0.99 (under $1), users can then buy 1 UST worth $0.99, and swap it on Terra Station for $1 worth of LUNA, earning them $0.01. LUNA’s supply would increase and UST’s supply would decrease in the process, theoretically bringing UST's price back to $1.

  • Similarly, if UST goes above $1.01, users can do the opposite: swap $1 worth of LUNA for 1 UST, earning them $0.01. UST’s supply would increase and LUNA’s supply would decrease in the process, theoretically bringing UST's price back to $1.

  • Overall, the relationship between UST and LUNA acts as a constant arbitrage opportunity for traders, incentivizing market forces to stabilize UST's price at $1.

So, what happened? How did the LUNA-UST algorithm get disrupted? Here’s a deep dive:

  • After a massive dump of UST on May 12, the price of the algorithmic stablecoin started to significantly de-peg from $1, causing mass panic and selling pressure in the markets. Because of this, traders were burning their UST in exchange for $1 of LUNA, which ballooned LUNA’s circulating supply. These then created a knock-on effect – further crashing the price of LUNA.
  • Essentially, the arbitrage opportunity will continue until UST’s value is restored to its $1 peg. Consequently, $LUNA may always be purchased at a discount through the Terra Station, forming a loop.

  • However, on May 15, UST’s price, which was meant to be stable at $1, dropped to a whopping $0.05 – losing almost 95% of its value in a few days.

  • This is believed to be due to liquidity issues, wherein funds got depleted from one of the major decentralized exchanges, Curve Finance, which caused massive retail and institutional panic selling. Similarly, as LUNA’s circulating supply multiplied, its price dumped to $0.000065 or by -99.99%.
UST/USDT Chart from TradingView

  • Terraform Labs has now abandoned LUNA and introduced a new chain called LUNA 2.0. The original LUNA was renamed Luna Classic ($LUNC), and holders of it were airdropped with LUNA 2.0 coins ($LUNA).

  • The recovery chances are still debatable, and the price of LUNA 2.0 remains significantly volatile. In fact, the only difference it has with the original LUNA is that LUNA 2.0 doesn’t have a stablecoin anymore.

So, is Terra over?

  Well, it may be over, given the devastation to Terraform Labs’ reputation, and that LUNA 2.0 has no difference from the original LUNA. But, who knows what will happen in the future? What if Terraform Labs has a plan to revive its reputation? Thus, it may also NOT be over yet for LUNA.

Bottom line

What happened was a complete disaster, both for beginners who are still discovering how crypto works and even other experienced investors who have been in the space for a long time were severely hit. Some even lost their entire savings. 

The industry is still maturing. Sure, it has huge potential to revolutionize the current financial system. However, we cannot deny that it still suffers from market manipulation, hacks, fraud, and a reckless FOMO culture. 

Internalize what you can learn from Terra’s failure. Understand more about how cryptocurrency works. No one will do the learning for you except yourself, and nobody is saving you if your investments fall apart. LUNA’s developers promised that everything was under control, but in reality, they still weren't able to contain the situation. 

At the end of the day, the market does not care about what you feel. It will do what it wants to do. Until then, you’ll realize that only you and your knowledge can mitigate risk. 

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