The past week has been a dark period in crypto history, with the industry’s total market capitalization falling to $1.2 trillion for the first time since July 2021. The turmoil has, in large part, been due to disintegration in real time Terra, a protocol based on Cosmos that drives a set of algorithmic stablecoins.
About a week ago, Terra (LUNA) was among the top 10 most valuable cryptocurrencies in the market, with a single token trading at a price point of $85. However, on May 11, the price of the asset had fallen to $15. And, 48 hours later, the token has lost 99.98% of its value, currently trading at a price point of $0.00003465.
Due to the ongoing crash, Terra’s other partner offering, TerraUSD (UST) – an algorithmic stablecoin pegged to the US dollar at a 1:1 ratio – has lost its dollar peg and is currently trading at 0.079527 Dollars.
Terra ecosystem explained
As noted above, the Terra protocol is governed by the use of two main tokens, namely UST and LUNA. Network participants have the ability to mint UST by burning LUNA on the Terra Station portal. In a nutshell, you can imagine that the Terra economy is primarily made up of two funds: one for TerraUSD and one for LUNA.
To maintain the value of UST, LUNA’s supply pool adds to or subtracts from its coffers, so customers must burn LUNA to mint UST and vice versa. All of these actions are incentivized by the platform’s algorithmic market module, which makes UST’s functional framework substantially different from that of its closest stablecoin rivals, Tether (UDST) and USD Coin (USDC), both of which are backed by active trust directly.
To illustrate the operation of UST (or algorithmic stablecoins in general), the best would be to use a simple illustration. Let’s say, for example, that the value of UST is set at $1.01, then users are incentivized to use Terra’s exchange module to exchange $1 worth of LUNA for 1 UST, pocketing a net profit of $ 0.01.
Now, when the tables turn and UST drops to $0.99, network users can do the exact opposite, causing the protocol to not allow some users to exchange $1 of UST for $1 of LUNA. This once hypothetical scenario is now a living reality, resulting not only in the disintegration of the Terra protocol, but also in the malignant reputation of the cryptocurrency industry in the eyes of investors around the world. .
Damage control, but in vain
As soon as LUNA and UST went into free fall earlier this week, protocol co-founder Do Kwon public a series of tweets announcing corrective measures to contain any further bleeding. As a preliminary measure to counter UST’s decoupling from the dollar, Kwon reinforced the burning of UST, something we now know in hindsight didn’t work.
2/ I understand that the last 72 hours have been extremely hard for all of you. Know that I am determined to work with each of you to get through this crisis, and we will build our way out.
— Do Kwon (@stablekwon) May 11, 2022
Kwon claimed that by increasing the pool from 50 million to 100 million special drawing rights (SDRs) and reducing the PoolRecoveryBlock from 36 to 18, the minting capacity of the protocol could go from $293 million to a whopping 1.2 trillions.
In short, implementing changes to the above, the Terra team was able to coin four times UST of nowhere, a process now known jokingly as kwontativa easing. Jack Tao, general manager of the exchanges of criptomonedas Phemex told Cointelegraph that, looking back, the signs of disaster surrounding LUNA UST and have been there for quite some time.
For starters, think the general idea surrounding the algorithmic stablecoins itself is rather weak, since these deals lack any real asset backing. Second, the Moon Foundation had recently done much noise as Kwon Do announced that he would buy a total of 10,000 million in Bitcoin (BTC) to serve reservations UST. In this regard, Tao added:
“These purchases led to an oversupply of UST, which began to fall off rapidly once selling pressure began to build on LUNA and then subsequently on UST. Once this sale occurred, the Luna Foundation Guard had to unload its Bitcoin to maintain parity. But, the reflexive selling pressure continued and all the assets involved began to fall sharply.”
Tao went on to add that the Protocol -a platform Anchor savings, lending and borrowing built in the Terra Blockchain- promised an unreal 20% annual percentage yield (APY) in the staking of UST, also it played an important role in development. When selling pressure on UST rose, he lost his peg of $ 1.00 and began to uncontrollably fall:
“Once Binance’s liquidity dried up, Curve’s two UST pools began selling UST, and Anchor’s lending levels dropped by over $1 billion. As a result of this, the broader ecosystem has been plagued with trust issues, especially when it comes to stablecoins.”
Terra officially goes offline after the collapse, albeit briefly
On May 12, validators serving the Terra network decided collectively ending any digital activity related to the ecosystem in an attempt to mitigate potential governance attacks, especially as the network’s LUNA token dipped below a penny recently.
Up to this point, the official Terraform Labs Twitter account revealed that all network activity had stopped at block height 7,603,700. With LUNA’s value falling by almost 100%, the firm’s spokesperson suggested that developers no longer trust its abilities to prevent third-party governance hacks. However, the downtime was short-lived, with the Terra core team revealing that it would restart operations as soon as validators could apply a patch that would disable all additional delegations.
As a result of the fall of the LUNA / USDT commercial pair below the 0,005 mark USDT, he withdrew from the list of Binance. The move followed the withdrawal of tokens LUNA by exchanges of criptomonedas Huobi just a day before. Before the above events occur, UST was the third largest stablecoin by total capitalization of the market, behind only Tether and USD Coin.
A bad image for the sector as a whole
In Tao’s opinion, this whole episode is going to have a negative impact on the image of the cryptocurrency industry, especially in the eyes of investors. In particular, he believes the drop could result in lawmakers getting tougher around decentralized stablecoins and could even lead many governments to aggressively explore creating their own centralized stablecoins and central bank digital currencies (CBDCs). , adding:
“The situation LUNA, unfortunately, leave a bad taste to everyone, as this has caused many large altcoins lost tremendous value. But a more important aspect of this event is your time. All this has happened at a time when there is a war raging in Europe of the East, supply chains are restricting globally, inflation and interest rates are rising. “
That said, he admitted there might be a small silver lining in all of this: The event may result in only the best projects surviving, with most sketchy platforms losing investor interest in a big way. “There will be a lot more scrutiny going forward and investors will feel comfortable choosing to only invest in the biggest cryptocurrencies, like Bitcoin, Ether and Solana,” she said.
So it will be interesting to see how this story continues to unfold and what kind of repercussions this incident has on the development/evolution of the cryptocurrency market in general, especially as the traditional financial system also continues to be plagued by an increasing amount of adverse financial pressure. .