how this crypto collapsed?

Since May 9, 2022, the cryptocurrency market has been in a critical situation, marked by the panic of many investors. The Terra crisis manifested itself with a speed and intensity that should mark the history of cryptocurrencies for a long time to come. In just a few days, the LUNA cryptocurrency lost nearly 99.9% of its value after the UST stablecoin lost parity with the dollar.

This major crisis caused significant losses for many investors, as well as a crisis of confidence across an entire segment of the cryptocurrency market. This panic, of rare brutality, should have a lasting impact on the cryptocurrency market. Deciphering the Terra crisis and its implications for the virtual currency market.

What is Terra?

etoro virtual currency
Terra brings together several cryptocurrencies, including the stablecoin TerraUSD (UST), which guaranteed 1 to 1 parity with the dollar, and the cryptocurrency LUNA, the cryptocurrency of the Blockchain Terra. When it launched in April 2019, Terra presented itself as: “trying to disrupt the traditional financial system by rebuilding the payment system on the blockchain and powering all digital transactions with our stablecoin”† On the other hand, the stablecoin UST, an algorithmic stablecoin, was launched in September 2020. The launch presentation described the UST as “an algorithmic stablecoin, where the coin costs are equal to the face value of the minted stablecoins – to mint 1 TerraUSD, only $1 of the reserve power ($LUNA) needs to be burned. TerraUSD’s monetary policy is infinitely scalable […] †

At the beginning of 2022, the cryptocurrency of Terra (LUNA) was still the 9e global cryptocurrency with a capitalization of more than $30 billion. For its part, the stablecoin UST had reached a capitalization of up to $19 billion a few weeks before the crisis. Now the LUNA cryptocurrency stands at 206e on May 15, 2022, and the stablecoin UST is at 35e

Paradoxically, the UST project was launched that specifically claimed to respond to the parity problems of the Dai, a stablecoin that reproduces parity 1 for 1 with the dollar (1$ = 1UST). Indeed, the Dai faced parity issues as early as 2020. The Dai appeared with a supply and demand system similar to that of the Terra USD. Indeed, Dai’s supply is secured by holding several crypto-currencies (especially Ethereum) which guarantee parity with the dollar. However, despite the greater scalability of the UST, the problem of maintaining parity appears to be clearly unresolved.

Also read our guide How to invest in cryptocurrencies in 2022?

Terra USD and LUNA: which links?

TerraUSD (also abbreviated UST) and the Blockchain cryptocurrency Terra (abbreviated LUNA), are two highly connected cryptocurrencies. The presence of a strong dependency between the two cryptocurrencies is one of the main causes of the rapid collapse of the entire Terra ecosystem. Indeed, the parity with the dollar of the stablecoin UST was mainly ensured by the manipulation of the LUNA. When the UST was worth more than $1, LUNA tokens were destroyed to increase the stock of UST. Conversely, when the UST was worth less than $1, LUNA tokens were bought by reducing UST’s supply.

This system of interdependence necessarily increases the risk of running away in the event of a crisis. In addition, the presence of algorithmic management of the stablecoin could reflect the presence of risks of loss of control.

In addition, the TerraUSD (UST) stable currency has been the subject of much speculative enthusiasm. Indeed, Terra launched a yield protocol called Anchor in the summer of 2021. This program was essentially intended to provide returns in exchange for storing USDT stablecoin on the platform. The yields offered were almost 20%.

Finally, we will insist on the importance of Ethereum in this speculative mechanism. The presentation of the UST in 2020 stated that: “when demand for borrowing for Ethereum is high, interest rates go up and when demand is low, interest rates fall”

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Terra: how did the crisis start?

For example, the gradual decline in the price of cryptocurrencies in early May, and in particular the decline in demand for Ethreum, likely increased the risks of a crisis. Anchor’s ANC price, which represents investor interest in UST returns, peaked at 5.2 UST on March 5, 2022, from 1.2 UST on May 15. The ANC’s past decline in prices, which also points to interest in the UST yields, could be the first sign of a weakening ecosystem.

The company’s explanations for Terra’s fall show that the process of ecosystem collapse was very rapid. As early as May 9, liquidity reserves are said to have been emptied for the first time after the UST began trading slightly below par with the dollar. At the same time, the presence of short selling on the LUNA token depressed the price of LUNA and thus the stability guarantees of the UST. To regain parity, Terra tried to spend even more LUNAs to prevent the collapse of the UST. However, these measures have remained insufficient, despite the company even selling its $1.5 billion Terra Treasury. The Terra Panic is similar to a bank run 3.0, enhanced by powerful computer interdependence mechanisms.

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Terra Luna: The Collapse of Crypto in 24 Hours!

The speed of the collapse of the cryptocurrency LUNA and the stablecoin UST is worth analyzing. On the one hand, the UST stablecoin fell from $1 on May 9, 2022 to $0.13 on May 13, 2022 (-87%). On the other hand, the LUNA cryptocurrency dropped from its high of $118 on April 4 to $63 on May 9, 2022, before closing below $0.1 (-99.9%!) on May 13, 2022. This represents the evaporation of the equivalent of $39 billion in capitalization on LUNA and $16 billion in capitalization on UST (a loss of more than $50 billion in capitalization in the ecosystem).

A move of such magnitude caused panic among many investors and internet users. Like the youtuber KSI crypto who claims to have lost nearly $3 million in just 24 hours, there are many testimonials from hundreds of investors who have lost tens or even hundreds of thousands of dollars or more. The crypto ecosystem is permanently dominated by this crisis. It is rare to find an active member of the cryptocurrency market who does not know at least one person affected by this collapse.

Faced with such a move, the suspicions of Internet users have multiplied. Cardano cryptocurrency founder Charles Hoskinson even speculated market manipulation by financial giants BlackRock and Citadel. These rumors were quickly denied by the main involved. For their part, exchange platforms like Binance have stopped trading UST and LUNA cryptocurrencies.

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Are stablecoins that safe?

Here we must now distinguish between two main categories of cryptocurrencies that are based on fundamentally different guarantees. On the one hand, there are classic stablecoins that are theoretically guaranteed by their equivalent in the form of hard currencies or bonds. These are mainly stablecoins USDC (USD Coin), USDT (Tether USD) or BUSD (Binance USD). These stablecoins experienced no signs of decorrelation during the crisis and showed better resilience.

On the other hand, there are algorithmic stablecoins that are guaranteed by a range of other crypto currencies. These are mainly the Dai and the UST. These stablecoins showed greater signs of weakness. The collapse in parity between the UST and the dollar confirmed the risk of losing parity against the dollar. Regardless, both categories of stablecoins benefited from a speculative move. Various protocols are accessible for users to enjoy returns on their stablecoins. Some internet users have not hesitated to criticize this system as a “Ponzi” scheme, which consists in paying for investors’ interests with the money of new investors.

As a reminder, stablecoins represent about 10% of the entire cryptocurrency market and weigh a large portion of the trade made. It is difficult to imagine the cryptocurrency market today without stablecoins. In addition to their stability qualities, stable coins had a purely utilitarian aspect between individuals or institutions. As of now, stablecoins are questioning their security in the face of crises and especially their reliability and their sincerity with regard to the guarantees offered. To date, most stablecoins seem to maintain their parity, but this crisis has shown that the risk of a total and rapid collapse cannot be ruled out.

Also see our Stablecoin file: why and how to invest?

Terra Luna: doubts about stablecoins and cryptocurrency in general?

Several days after the LUNA collapse, the price appears to be showing no signs of an effective rebound. However, the UST rose towards the USD 0.2 level on May 15, but a $1 parity still seems a long way off. A revival of the Terra ecosystem is unlikely, and a return to pre-crisis thresholds, especially on LUNA, seems unrealistic given the current market environment and market sentiment.

In addition, several ecosystems are affected, such as entrepreneur Owen Simonin’s company Just Mining, which is exhibited at the UST. Apart from this example, this raises the question of the spread of such crises to the entire cryptocurrency market. In any case, the absence of liquidity in the stock markets for several months, driven by central banks and the macroeconomic context, has exposed inherent weaknesses in cryptocurrencies. The Terra crisis will remain a historic crisis for the cryptocurrency market, which as a whole lost the equivalent of $350 billion in capitalization in the span of 4 days (-23%).

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