News & Analysis
News & Analysis

Terra Luna and its collapse

16 May 2022 By Christian Ramos

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If you follow my articles, you will see that from time to time, I delved into areas that are not directly link to trading CFDs, this is because I have a variety of topics within finance that I have a passion for and acquiring more knowledge (not matter how limited in my case is) is never a bad thing. Today, I want to discuss the Cryptocurrency Terra Luna and why it has collapsed in the last week. At the same time talk about what a StableCoin.

What is Terra Luna?

Do Kwon, the Co-Founder and CEO of Terra, wanted to use blockchain technology to develop a more efficient payment system. Its eponymous price-stable cryptocurrency, or stablecoin, attracted 40 million users to work with the company at launch in January 2018. The stablecoin is called UST Tether, its only product. The idea of a stablecoin is to give purchasing power to the customer. The coin is pegged to a currency that is widely known, recognised and used in the wider Fiat market, in this instance it was the US Dollar. Do Kwon’s idea was to produce a peer-to-peer electronic payment currency in the vision of what many believe Bitcoin or Ethereum would be used for; albeit many now treat Bitcoin as “digital gold” or a “hedge against inflation”. Ethereum is also treated as a network much like the internet, where different tech companies or services operate from, with the added capability of issuing Smart Contracts. But I digress, Terra (UST) is a stablecoin, which is meant to be worth $US1, however, its value is backed by a “sister” token called Luna.

Some Tokenomics to understand the failure.

“Luna was impacted because it’s the underlying [backer] of the UST, Luna’s value plunged 99pc, causing some investors to lose their life savings. So, every time a UST [token] is bought, a Luna [token] is burnt, which means there’s less tokens in supply, so the Luna price goes up.

“The reverse applies when people start selling. So, every time someone sells a UST, they mint a Luna, which means there’s more volume.

“And if there’s no buyers and the price goes down, then it starts to feed on itself, because people start panicking and selling Luna.

While the network is built around smart contracts and complex mix of algorithms, the system can be manipulated by high frequency trading at a time where there is a low volume of trades. In this case, “They waited until Saturday night when [trading] volumes were very low, and there were no bids. And then they went into a trading pool and started selling UST in massive volumes, which then triggered all of the subsequent selling in a low-volume market that broke the [US dollar] peg. With big enough trades or big enough multiple trades, it can send the market to the point where you want it to go, in this case cause a death spiral where the two currencies where to slow to boost each other and the fear of the people wanting to liquidate their assets sent the currency to its death bed.”

In the end Luna’s value of $40 billion dollars was wiped out, not specifically, it is now worth around $400 million, but in the large scheme of things its hard to have faith in the project rebounding instead maybe have a snail type death, where investors lose faith in the project and it grinds to a halt.

This makes more sense when you realise that the value of Luna was also directly link to the savings pool; “That savings pool was offering 20 per cent returns.” Where investors, normal day to day people and perhaps bigger hedge funds would deposit their funds in it, in return for weekly, monthly, yearly returns. This is fact is what made this cryptocurrency so popular, it was DeFi, Decentralised Finance at its core!

This would probably bring about tighter regulation in the Crypto world or more fear, but what is important to take from this is that if you are looking to invest in this young industry, it pays to be extra careful with who you invest with, and as usual “DYOR” – do your own research.

Disclaimer: Articles are from GO Markets analysts and contributors and are based on their independent analysis or personal experiences. Views, opinions or trading styles expressed are their own, and should not be taken as either representative of or shared by GO Markets. Advice, if any, is of a ‘general’ nature and not based on your personal objectives, financial situation or needs. Consider how appropriate the advice, if any, is to your objectives, financial situation and needs, before acting on the advice. If the advice relates to acquiring a particular financial product, you should obtain and consider the Product Disclosure Statement (PDS) and Financial Services Guide (FSG) for that product before making any decisions.

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