When it rains it pours the old saying goes. This old wisdom applies to things old and new it seems like those in the cryptocurrency world are gripped by a major decline in the markets. Bitcoin the leading cryptocurrency is currently in a tailspin that has it trading at 12-month lows. The Altcoins and tokens are not fairing any better with Ether (ETH -33.30%),Binance (BNB -30.11%), stable coin Tether (USDT -0.15%), Ripple (XRP -7.83%), Cardano (ADA -70.1%), Dogecoin (DOGE -79.36%),Lite coin (LTC -71.70%), Stellar Lumen (XLM -76.23%), Cosmos (ATOM -37.99%), Vechain (VET -77.61%) ,Filecoin (FIL -90.79%) all down from 1 year ago. You’d have to dig deep to find a cryptocurrency that’s up from last year. Decentraland (MANA) is a rare example that is up year-on-year but 69.79% down on a year to date basis. The hardest hit was Luna which plummetted to zero, yes nothing recently. What exactly is going on in the cryptocurrency space?
As cryptocurrencies rallied last year the predictions were anything from Bitcoin to reach US$100 000 to US$300 000 by the end of 2022. As it reached the US$60 000 mark the bullish attitude continued in the markets, then something happened on the way to heaven. Bitcoin crashed and is now trading between $28 000 to $31 000. It’s important to note that the slump is not unique to cryptocurrency since the invasion of Ukraine by Russia over a NATO membership dispute markets across the world have felt the ripple effects of this action. In addition to this China placed a ban on cryptocurrency-related payments and warned against speculative investing in the markets. This ban has been a long time coming. As it matures cryptocurrency is becoming more connected to the world before it and we see some sympathetic resonance emerging with stock markets. The S&P 500 is down 6.21% over 1 year and 18.68% year to date. The wild turns in crypto are testament to the extreme volatility in digital assets. Volatility simply amplifies what other markets are feeling.
What happened to Terra and LUNA?
It was all a dream. Terra (UST) was established as a stable coin, a coin that would keep up value reasonably with the US dollar. Terra and LUNA were both tied to the Terra blockchain. Luna with a market cap of US$40 billion on the chain was certainly a big deal. The relationship between the two tokens is also important to the collapse. Terra could always be exchanged for $1 worth of LUNA but the LUNA would be burned (destroyed) keeping the money supply in the blockchain in check. Terra also offered a staking (lending) program where holders could earn 19.5% per annum on their Terra. Terraform Labs CEO Do Kwon went on to create the Luna Foundation guard which held US$2.3 billion worth of Bitcoin reserves to defend the value of Terra. If Terra dropped below $1 they would sell Bitcoin for Terra to return its value to $1 and if Terra appreciated they would sell Terra to return the value to $1.
On Saturday the 7th of May over US$2 billion worth of Terra was withdrawn from the staking (lending) program. Up to half of that was immediately sold. Such huge selling action pushed the price of Terra down to 91 cents. An arbitrage opportunity arose and speculators tried to take advantage of it. The opportunity came from that relationship between Terra and Luna. You could always exchange $1 worth of Terra for $1 worth of Luna and vice versa. The big sell-off in Terra did not affect the price of Luna so speculators tried to exchange their Terra (worth 90 cents) for $1 worth of Luna but hit a brick wall. Only US$100 million of UST could be burned for Luna per day. On Monday the 9th of May, Terra’s USD peg could not be defended (Zimbabweans can relate)and the market pushed to get rid of both Terra and Luna. Luna plummeted from an April high of $120 to 0.002 cents. As Terra holders sold off Terra, Terraform labs would sell-off Bitcoin to try to defend the peg. Sending both in a tailspin. Luna was dragged down because of its fungibility with Terra. At the time of writing the Terra blockchain is suspended.
The fall of Terra, Luna and the Terra blockchain brings up major questions over stable coins and Decentralised Finance (DeFi) tokens as a whole. Major questions over the peg and the fund established to defend the peg continue to be brought up. With the crypto markets shaken and Terra blockchain suspended there are rumours that the domino that started the collapse, and the huge sell off in Terra were part of an intentionally coordinated attack on the stable coin.