It was 1981 when “Iron” Mike Tyson won his first gold medal by defeating Joe Cortez. A mere year later, he reprised his success by beating Kelton Brown. He then went on to build a professional career unlike that of any other athlete. Nicknamed the “baddest man on the planet,” Iron Mike soon seemed to have it all: fortune, fame, and heavyweight titles in hand.
However, while fans worldwide witnessed this legend in the making, no one could assume he would soon go down a path to disaster, spiraling down to his ultimate downfall. Regardless, Mike Tyson is one-of-a-kind because he did something that no one else did before.
The parallel&
Just like the protagonist (or antagonist, depending on your worldview) mentioned above, the Terra Luna blockchain also went through thick and thin. This crypto had a value of $40 billion at one point, but suddenly crashed. In May 2022, the world of cryptocurrencies witnessed one of its most surprising and significant crashes in history: the price of LUNA went down to almost zero. In a matter of days, investors lost more than $40 billion in a crash of unprecedented proportions.&
Source: Coinmarketcap
Consequently, this cryptocurrency earned a near-permanent residence in headlines worldwide. In doing so, it provided a daunting example of the potential volatility of cryptocurrency markets. However, countless crypto enthusiasts still wonder what happened, and how LUNA’s crash impacted other coins. We’ve rounded up the crucial information for you below.
The Terra Luna crash: How it all began
Terraform Labs was launched in 2018 by South Korean Do Kwon, following his previously unsuccessful digital currency project, Basis. The company essentially created two sister digital currencies: Luna and TerraUSD (UST), with each serving different purposes.
On the one hand, UST was designed to be a stablecoin — meaning that its value remains pegged at $1. However, contrary to traditional stablecoins, UST is more algorithmic, meaning its value isn’t backed by physical holdings or assets.
On the other hand, UST’s sister/partner currency — Luna — was intended to balance the two while maintaining UST’s dollar peg. Therefore, like other cryptocurrencies, Luna rises and falls, while UST’s value is consistently (more or less) equal to a dollar.&
More precisely, Terra’s system works as follows: minting one UST is equal to burning a dollar-worth of Luna (and the other way around). In theory, such a relationship stabilizes the price by balancing out the supply and demand of the coins. In other words, investor assets and the coin value are protected by the “algorithmic” dollar.
Therefore, ensuring the integrity and “balance” of the Terra ecosystem and the algorithm itself requires that the value of UST does not drop below a dollar or continue to plummet. But, this is precisely what happened to this cryptocurrency, leaving countless investors and individuals with a quintessential question: how did this happen?
Setting the stage for the crash
Before nosediving to $0.04 in May 2022, UST recorded an all-time high of $1.09 for more than a year (since 2021). Simultaneously, UST’s sister coin Luna was also at an all-time high of $119 before historically dropping to $0. When the crash began, investors panicked and immediately scrambled to liquidate their assets.&
Following an overnight 100% drop in the token’s price on May 16, 2022, the Terra blockchain halted its operations. In hindsight, several reasons led to this occurrence.
The most significant reason is the overall crypto market, which had already been bleeding. The first two weeks of May saw Bitcoin plunging, including most other cryptocurrencies, which pushed Luna’s value downward. Consequently, since UST relies on Luna to absorb price volatility shocks, it also went below a dollar.&
Source: Coinmarketcap
The chain’s borrowing/lending platform — Anchor protocol — is another significant reason for the crash. Investors who loaned UST back to Anchor after buying it were given a promise of a 20% annual percentage yield by the Terra network.&
However, at one point, Anchor contained 75% of UST coins, making two things clear. One, Terra was using the protocol to attract capital, and two, investors were after the 20% APY. As was to be expected, they panicked and ran for the exit following news of UST de-pegging and Luna losing value. Consequently, the protocol ended up dry.
Was it over before it even began?
Terra Luna was founded under the promise of an algorithmic stablecoin without collateral or fiat guarantees to protect investors and hedge against cryptocurrency volatility. However, this promise was broken in May 2022, causing the industry to re-examine the architecture of the crypto subsector.&
Indeed, this architecture was already risky from the outset. According to the University of Calgary Faculty of Law’s Dr. Ryan Clements, algorithmic stablecoins are “fundamentally flawed.” In his study “Built to Fail: The Inherent Fragility of Algorithmic Stablecoins,” Clements states that these coins exist in “…perpetual vulnerability.”
Since it has no guarantee from fiat reserves or collaterals whatsoever, and because it predominantly relies on demand volume and market sentiment, the Terra ecosystem is believed to have been unsustainable from the very beginning.&
Where is Terra Luna now?
In the weeks following its collapse and after a community vote, Terra was forked, with the new chain (Terra or Terra 2.0) replacing the old one (named Terra Classic). Besides existing without UST, the new Terra functions like other Layer 1 smart contract platforms.
Consequently, the updated chain contains numerous apps that existed on the old Terra Classic, including new ones. However, the updated network has failed to gain traction even though it offers identical opportunities and utility, as Terra Classic did prior to its collapse.&
As of June 30, Terra 2.0 amassed approximately $270 million in value for $2.12 per token. Compared to when it went live in late May 2022, this represents an approximate drop of 82.5% in value. Therefore, those in the cryptocurrency community won’t forget the collapse of Luna any time soon despite the new coin marking a reset for the network.
Conclusion
When Terra Classic first went live, it wowed the cryptocurrency community as a new and prospective stablecoin. It performed well and seemed to check all the boxes of a reliable crypto coin.
In hindsight, and considering everything mentioned above, its crash was not all that surprising. Simultaneously, it is challenging to say whether other blockchain ecosystems will follow the same path as Terra in the future. One must remember that this was a unique and possibly ill-timed project.
Regardless, Terra Luna attempted to look at things differently.
Despite ending in failure, it challenged existing standards and made it to the top for a short time.
Ultimately, Terra Luna did something no one else did before — just like Iron Mike, it went full circle and is still around today.
Disclaimer: Information provided by CEX.IO is not intended to be, nor should it be construed as financial, tax or legal advice. The risk of loss in trading or holding digital assets can be substantial. You should carefully consider whether interacting with, holding, or trading digital assets is suitable for you in light of the risk involved and your financial condition. You should take into consideration your level of experience and seek independent advice if necessary regarding your specific circumstances. CEX.IO is not engaged in the offer, sale, or trading of securities. Please refer to the Terms of Use for more details.
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