Thursday, 12 May 2022

Terra (Luna) Coin: what happens after the stable coin crash?

With the Terra USD, Terra offered a stablecoin with an innovative mechanism – now the system has crashed.

The Terra blockchain network suffered a 96 percent loss in one week: With this balance sheet, the success story of the innovative stablecoin Terra (Luna) comes to an end for the time being. How can it go on?

Until a few days ago, Terra (Luna) was a successful network with an innovative stablecoin. Instead of physically depositing fiat currency, Terra (Luna) relies on an algorithm that is intended to tie the rate to the US dollar. Exactly this algorithm was the currency's undoing. 

Investors who bought Terra (Luna) are shocked. While the currency was around 85 US dollars (equivalent to 80 euros) on May 5, 2022, the current exchange rate (May 12, 2022) is only 0.06 US dollars. Why has the stablecoin price decoupled from the US dollar? And is there a realistic way the coin could recover? explains what is behind the Terra crash.

What is Terra (Luna)?

Terra is a blockchain that offers the stablecoin Terra USD in addition to the Luna token. Similar to Ethereum or Solana, the Terra blockchain makes it possible to conclude smart contracts and process payments. The Terra Network was founded by South Korean developers Daniel Shin and Do Kown. In 2018, the founders secured investments of 32 million US dollars for the project.

How does the Terra Blockchain work?

What is innovative about the Terra Network is the mechanism by which it generates price-stable stablecoins. While other stablecoins invest in physical cash reserves, Terra ensures stability via an algorithm in its own network. This allows the Terra stablecoin to stably express different currencies. In addition to the Terra USD, there are also Terra stablecoins for the euro, yuan, yen and pound sterling. In addition, a lively ecosystem of various decentralized apps (dApps) was created around the Terra blockchain, which, for example, process digital payments using the Terra blockchain.

Terra (Luna) Crash: Why did the stablecoin crash?

With the Terra USD, the rate binding does not result from physical purchases of fiat currency, but from the possibility of being able to exchange Luna for UST at any time at a fixed rate. If the Terra USD is above the $1 target, investors are incentivized to trade their Luna for UST and make a profit through the arbitrage. At the same time, the exchange rate oscillates back to 1 US dollar.

Recently, however, this concept no longer worked. Instead, the price has been in free fall since May 5, 2022. The Luna Foundation and many investors speculated on Twitter about a targeted attack on the network. In fact, users of the platform outlined months ago how an attack on the network with a capital of 1 billion US dollars could succeed.

In any case, the recent crash of the algorithmic stablecoin proves the critics right, who previously pointed to possible weaknesses in the system.

Terra (Luna) Prediction: Should Investors Buy Terra (Luna)?

Terra has attracted many investors with its innovative approach to mathematical price stabilization, but the network has come under criticism for the same reason. Some experts criticize the algorithmically generated price stability because it is ultimately based on the assumption that the independent network participants act economically and rationally in the interest of the network.

The strong increase in the Luna price was also due to the offer of a decentralized app on the Terra blockchain. The Anchor Protocol offered investors a 20 percent annual return on deposits in Terra USD, which naturally increased demand for the Luna token. However, critics argue that such offers do not allow long-term sustainable economic activity and thus artificially inflate demand.

The crash seems to agree with the critics on many points. Terra developer Do Kwon announced comprehensive measures to stabilize the network on Twitter. However, this includes a massive devaluation and high losses for the previous investors.

New investors should be particularly careful at the moment. Nobody knows how far the Luna price will fall and whether a recovery is conceivable in the medium term. According to media reports, the US Securities and Exchange Commission is already preparing a lawsuit against the operators of the network.

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