The Terra LUNA crash in May clarified that cryptocurrency is not safe from facing major financial crises. Far from being an error or a bug, it might be systemic.

What is the Terra LUNA Project?

Terra LUNA is a blockchain project founded by Terraform Labs in 2018 in Seoul. This project has two significant tokens at the heart of its ecosystem. First of all, the native token of the ecosystem is the LUNA. This is the one used to pay transaction fees on the blockchain. At the heart of the ecosystem is the stablecoin named TerraUST. TerraUST is indexed to the dollar's value, but it is algorithmic. Terra LUNA, which was still, at the beginning of 2022, the 9th largest crypto with a capitalization of more than $30 billion, has collapsed, sinking 99.9% in the space of 24 hours in May. 

Why did Terra LUNA crash?

Most major stablecoins like USDT and USDC are backed by dollars. In theory, for every crypto issued, an equivalent amount is purchased in the U.S. Treasury bills and placed in a reserve account. TerraUSD, on the other hand, is what we call an algorithmic stablecoin. Maintaining its parity with the dollar relies on computer processes managing the link between the two cryptos, TerraUSD and Terra. It's an innovative model of stablecoin that doesn't require as much collateralization as traditional models, but it's also a new system with many flaws. The problem is caught up in the crypto market storm; Terra LUNA has stalled. Its value dropped so much that the arbitrage mechanisms could no longer support the TerraUSD. No one knows whether there was a specific attack on Terra LUNA, even though many rumours circulated. But what is sure is that a huge volume of UST was rapidly exchanged for Terra Luna, creating never-before-seen hyperinflation.

A crypto crash in 24 hours

The speed of the collapse of the Terra LUNA cryptocurrency and the UST stablecoin is worth analysing. On the one hand, the UST stablecoin went from $1 on May 9, 2022 to $0.13 on May 13, 2022 (-87%). On the other hand, the cryptocurrency LUNA went from its high of $118 on April 4 to $63 on May 9, 2022, before ending below $0.1 on May 13, 2022 (-99.9%). This represents the evaporation of the equivalent of $39 billion in capitalization on LUNA and $16 billion in capitalization on UST (a loss of more than $50 billion in capitalization in the ecosystem). A move of such magnitude has caused panic among many investors. The crypto ecosystem is and will be permanently marked by this crisis.

Lessons Learned for the Crypto world

On May 28, 2022, "the old Terra LUNA chain hard forked, setting a new Terra (LUNA) blockchain, LUNA 2.0, into motion." We will see if Terra LUNA can be reborn from its own ashes. Still, there are many lessons to be learned in reflecting on this crash, not just about the stability and persistence of algorithmic stablecoin, but also about financial education for new investors and newcomers on the risks associated with investing in this class of asset. Crypto industry leader Ryan Selkis, Co-Founder of Messari, a company that helps investors, regulators, and the public to understand the crypto economy, has called for the industry "to step up its self-policing". Maybe, as stated in a recent Nasdaq article, even before thinking of self-regulation, it would be good sense to come back to Satoshi Nakamoto's basic principles: "start with smaller, safer bets in this space, like allocating no more than 1% to 2% of your wealth to a digital asset like Bitcoin." 

Diversification and caution are critical in a volatile but promising new space. It is time to learn and move ahead while being meticulous. 

Publié le 14 juin 2022