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The great Terra Luna crypto crash: Here are five points to note

Here are the five important things to know about the Luna crypto crash.

Here's what happened to Terra coin. (Photo: Pixabay)

In the last few days, a stablecoin called TerraUSD and its sister currency Luna dropped about 80 per cent, rattling the broader crypto market including tokens like Bitcoin and Ethereum. Terra Luna is now almost worthless. This has created fear among investors, even aggressively bullish crypto investors are now panicking. Here are the five important things to know about the Luna crypto crash.

Luna and Terra stablecoin

A stablecoin is a cryptocurrency pegged to be like the US dollar or Euro, meaning that its price remains stable—they are meant to be less volatile than other cryptocurrencies like Bitcoin or Ethereum, which are considered more volatile or subject to a sudden rise or fall.

Investors turn to stablecoins when they want to earn a decent profit and avoid the usual volatility associated with crypto. Some popular stable coins are Tether and USD Coin. Any stablecoin fixed to USD should ideally maintain its value of $1 per token, but this is not what happened in the case of the Luna-Terra crash.

TerraUSD is an algorithmically designed stablecoin, which means it maintains the same value as USD by using a complex mechanism with a related sister cryptocurrency called Luna. It is worth noting that Luna and Terra are created by the same developers. To maintain the price of Terra, the Luna supply pool adds and subtracts from Terra’s supply. Users then burn (sell off) Luna to mint Terra and even burn Terra to mint Luna. This is all done via an algorithmic module designed by the blockchain developers.

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For instance, say the value of a Terra coin plunges to $0.80 and since you can exchange $1 worth of Terra for $1 Luna, smart investors can quickly earn a small profit of 20 cent by burning their TerraUSD.

Balancing act

The whole concept of Terra and Luna is based on supply and demand. This balancing was necessary for investors to book small cuts but stable profits. However, last week the balancing act between TerraUSD and Luna broke. People were largely holding Terra because of something called Anchor Protocol. Think of the Anchor Protocol as your savings bank account. Every Terra holder was paid 20 per cent interest for parking their token in the Anchor protocol.

For the last several months, people were earning 20 per cent fixed interest that came from Anchor accounts. According to Coindesk, almost 75 per cent of the total Terra circulation was deposited in Anchor.

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However, things took a u-turn over the weekend, when large amounts of TerraUSD were suddenly withdrawn from Anchor based on the rumour that Terra is changing the fixed rate of 20 per cent interest to a variable rate. This caused worry among investors, who then started selling off their Terra tokens and swapping them for other stablecoins.

The majority of the people now started exchanging TerraUSD for Luna. Ultimately, the supply of Luna spiked, and its price plummeted. With more and more people dumping the Terra coin, the balancing mechanism stopped and both the coins—Terra and Luna crashed. According to Coinmarketcap, the Terra coin price dropped to a whopping 0.225 on May 11, meaning that what was meant to be a stablecoin lost almost 80 per cent of its value in a few days.

Crypto crash

Fear is the biggest factor that drives a bearish sentiment in the crypto market. As Terra fell, crypto investors panicked and started selling other coins as well, eventually crashing the crypto market. The world’s largest crypto Bitcoin plunged to $25,400 on Thursday. However, since then, it has shown tepid signs of stability. According to Coinmarketcap, the entire crypto market now has a market capitalisation of $1.2 trillion, less than half of the $2.9 trillion it was worth in November 2021.

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Terra Blockchain halts

The Terra blockchain was halted for over nine hours after Terra’s price fell. The halt meant no new blocks were generated on the blockchain network. Crypto holders were not able to move their Terra assets until the blockchain was unfrozen. “Terra validators have decided to halt the Terra chain to prevent governance attacks following severe $LUNA inflation and a significantly reduced cost of attack,” the company tweeted.

Bitcoin reserves

A report by blockchain firm Elliptic revealed that at least $3.5 billion in Bitcoin were untraceable after Terra’s price crashed. According to Bloomberg, Luna Foundation Guard (LFG), a foundation set up by the Terra blockchain developers bought $3.5 billion worth of Bitcoin so that they would use it to buy Terra and maintain the one-to-one peg with the dollar. However, the report says that the funds are now emptied. Around $1.7 billion was sent from LFG wallets to a new address on May 9 in two transactions. It took a few hours to move in the whole amount via a Gemini crypto exchange.

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First published on: 16-05-2022 at 03:23:29 pm
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