If you’re an investor who held both LUNA and UST and woke up to a bloodbath and a freefall of BTC and other cryptocurrencies, you’re not alone. According to investor stories on Twitter and Reddit, people lost their life savings when almost $60 Billion of economic value vanished into thin air in just 48 hours.
In the wake of the failure of the Luna project and its linked stablecoin TerraUSD (UST), several LUNA investors went bankrupt and sceptical policymakers reviewed the damage to the TERRA blockchain and the loss of crypto market credibility. The crypto project was backed by high-profile investors like Three Arrows Capital (3AC), Coinbase Ventures, and Pantera Capital.
This article takes a high-level overview and highlights events that led to the infamous LUNA crash, explaining terms like stablecoins, pegging, and more.
What is Luna?
TERRA is an open-source blockchain with an ecosystem of decentralised applications (dApps) and developer tools. TERRA protocol’s native token LUNA is responsible for stabilising UST’s peg (Read below).
TerraUSD, the dollar-pegged cryptocurrency, shot to fame earlier this year when Terraform Labs’ affiliate Luna Foundation Guard (LFG) pledged to collect $10 billion worth of Bitcoin.
To simplify how LUNA worked, imagine the price of UST to be $1.02. The Terra Station portal allowed users to mint UST by burning Luna. Now, the users of Terra Station could trade $1 worth of LUNA for 1 UST, which would require burning (permanently destroying) 1 USD and minting 1 UST. Users could opt to sell 1 UST for $1.02, making a profit of $0.02 in the process.
The major reason investors bought UST was to profit from a platform called Anchor, which offered 20% returns to anyone who lent their UST to the protocol (Quite a scam in hindsight, eh?).
What is a stablecoin?
Stablecoins are cryptocurrencies pegged to a fiat currency, such as the dollar. In essence, the raison d’être of stablecoins is to keep their value steady, since they are pegged to fiat currencies. UST was the fourth-largest stablecoin after USDT, USDC, and BUSD, mimicking the price of US dollars and 1 UST hovering close to $1 (gone are the days).
Pegging involves linking a currency’s exchange rate to the currency of another country, usually in a 1:1 ratio. In the crypto market, pegged cryptocurrencies are assets whose value is linked to another asset to create a stable currency. In most cases, this peg is tied to the US dollar. TERRA was supposed to keep a 1-to-1 peg with the US dollar under the Terra ecosystem.
UST did not rely on assets to maintain its peg. As mentioned above, the process involved minting new UST tokens by burning LUNA tokens and anchoring TerraUSD (UST) to $1.
The downfall of Luna TERRA
It all started when Terra’s lending protocol Anchor and stablecoin exchange protocol Curve dumped large amounts of UST on May 8, leading to a drop in UST to $0.985. The LUNA Foundation Guard (LFG), a consortium by Terraform Labs’ co-founder and CEO Do Kwon, was forced to sell its assets (BTC and other holdings) and depleted its reserves to save UST, but in vain.
The entire event led to a liquidity crisis where people could redeem UST for LUNA (at less than 1/50 of a penny) causing panic in the crypto market. What was being touted as a blue-chip cryptocurrency is now questioned to be a quick-rich scheme.
The Terra (LUNA) crypto token initially crashed from $120 to $0.02, a 99.9% correction, the majority of which occurred within 48 hours. UST had a similar fate, and the price declined to a mere $35 cents instead of the supposed $1 (by May 12).
Over 90 groups have filed complaints against Do Kwon after the TerraUSD crash accusing him of illegal fundraising and fraud. Further, Daniel Shin, the co-founder of TerraForm Labs, had his house and offices raided by South Korea’s Joint Financial and Securities Crime Investigation Team.
Revival plan- Luna 2.0
The Luna and UST pairings were delisted (prior to trading suspensions) on several crypto exchanges following the crash. In the wake of the decline in the value of TerraUSD and Luna, Terraform Labs announced the launch of Luna 2.0, a new digital coin that is part of their revival strategy. Price fluctuations remain an issue with Luna 2.0.