Since May 9, 2022, the cryptocurrency market has been in a critical situation, marked by the panic of many investors. The Terra crisis manifested itself with a speed and intensity that should mark the history of cryptocurrencies for a long time. In just a few days, the LUNA cryptocurrency lost nearly 99.9% of its value after the UST stablecoin lost parity with the dollar.
The decryption of the Terra crisis and the effects on the virtual currency market. This major crisis caused considerable losses for many investors and a crisis of confidence in an entire segment of the cryptocurrency market. This panic, of rare brutality, should have a lasting impact on the cryptocurrency market.
What is Terra LUNA?
Terra brings together several cryptocurrencies, including the stablecoin TerraUSD (UST), which guarantees 1 to 1 parity with the dollar, and the cryptocurrency LUNA, which is the cryptocurrency of the Blockchain Terra. When launched in April 2019, Terra billed itself as "seeking to disrupt the traditional financial system by rebuilding the payment system on the blockchain and powering all digital transactions with our stablecoin." For its part, the stable coin UST, an algorithmic stablecoin, was launched in September 2020. The launch presentation described the UST as "an algorithmic stablecoin, where the cost of minting is equal to the face value of the minted stablecoins – for hitting 1 TerraUSD, only $1 of the reserve asset ($LUNA) needs to be burned. TerraUSD's monetary policy is infinitely scalable […]".
At the beginning of 2022, the cryptocurrency of Terra (LUNA) was still the 9th cryptocurrency in the world, with a capitalization of more than 30 billion dollars. The LUNA cryptocurrency was ranked 206th on May 15, 2022, and the UST stablecoin is ranked 35th. For its part, the stablecoin UST had reached a capitalization of up to $19 billion a few weeks before the crisis.
Paradoxically, the UST project was launched claiming, in particular, to respond to the parity problems of Dai, a stablecoin reproducing the parity 1 for 1 with the dollar (1$=1UST). Indeed, Dai had experienced parity problems as early as 2020. Dai appeared with a supply and demand system similar to Terra USD's. Indeed, the supply of Dai is ensured by holding various cryptocurrencies (Ethereum in particular), guaranteeing parity with the dollar. However, despite the greater scalability of the UST, the problem of maintaining parity seems not to have been resolved.
Terra USD and LUNA: what links?
TerraUSD (abbreviated UST) and the cryptocurrency of the Blockchain Terra (abbreviated LUNA) are two strongly interrelated cryptocurrencies. A strong dependence between the two cryptocurrencies is one of the leading causes of the rapid collapse of the entire Terra ecosystem. Indeed, the parity with the dollar of the stablecoin UST was ensured mainly through the manipulation of the LUNA. When the UST was worth more than $1, LUNA tokens were destroyed to increase the supply of UST. Conversely, when the UST was worth less than $1, LUNA tokens were purchased thanks to the reduction in the supply of UST.
This system of interdependence necessarily increased the risk of runaway in the event of a crisis. In addition, the algorithmic management of the stablecoin could reflect the risks of loss of control.
In addition, the stable coin TerraUSD (UST) has been the subject of great speculative enthusiasm. Indeed, Terra launched a summer of 2021 performance protocol called Anchor. This program was essentially intended to provide returns in exchange for storing USDT stablecoin on the platform. The yields offered were close to 20%.
Finally, we will insist on the importance of Ethereum in this speculative mechanism. The UST presentation in 2020 clarified that "when the borrowing demand for Ethereum is high, the interest rate goes up, and when the demand is low, the interest goes down."
Terra's UST and LUNA Collapse: How the Crisis Unfolded?
Anchor's ANC price, representing investors' interest in UST returns, peaked at 5.2 UST on March 5, 2022, from 1.2 UST on May 15. The last decline in the price of the ANC, which also indicates the interest in the returns associated with the UST, could constitute a first signal of the weakening of the ecosystem. Thus, the gradual decline in the price of cryptocurrencies in early May, particularly the reduction in demand for Ethereum, probably amplified the crisis risks.
The Terra Panic is similar to a 3.0 bank run, amplified by powerful computer interdependence mechanisms. The explanations put forward by the company for the fall of Terra show that the process of the collapse of the ecosystem was very rapid. As early as May 9, the liquidity reserves would have been emptied after the UST started trading slightly below parity with the dollar. At the same time, the presence of short selling on the LUNA token lowered the price of LUNA, and thus, the UST guarantees stability. To regain parity, Terra attempted to issue even more LUNAs to avoid the collapse of the UST. However, these measures have remained insufficient, even though the company has sold its $ 1.5 billion Terra Treasury.
Terra Luna: The collapse of crypto in 24 hours!
The speed of the collapse of the cryptocurrency LUNA and the stablecoin UST is worth analyzing. On the one hand, the UST stablecoin fell from $1 on May 9, 2022, to $0.13 on May 13, 2022 (-87%). On the other hand, the LUNA cryptocurrency fell 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 movement of such magnitude sparked panic among many investors and Internet users. Like the KSI crypto Youtuber who claims to have lost nearly $3 million in just 24 hours, there are many testimonials from hundreds of investors who have lost tens or even hundreds of thousands of dollars or more. The crypto ecosystem is permanently marked by this crisis. It is rare to find an active member of the cryptocurrency market who does not know at least one person impacted by this collapse.
Faced with such a movement, the suspicions of Internet users have multiplied. Cardano cryptocurrency founder Charles Hoskinson even speculated market manipulation by financial giants BlackRock and Citadel. These rumors were quickly denied by the main concerned. For their part, exchange platforms like Binance have stopped trading UST and LUNA cryptocurrencies.
Are Stablecoins the Safe Heaven of Crypto?
Here we must now distinguish between two main categories of cryptocurrencies based on fundamentally different guarantees. On the one hand, classic stablecoins are guaranteed in theory by their equivalent in the form of hard currency or bonds. These are mainly stablecoins USDC (USD Coin), USDT (Tether USD), or BUSD (Binance USD). These stablecoins did not experience any signals of decorrelation during the crisis and showed better resilience.
On the other hand, there are algorithmic stablecoins guaranteed by a set of other crypto-currencies. These are mainly Dai and UST. These stablecoins showed greater signs of weakness. The collapse of the parity between the UST and the dollar confirmed the risk of losing parity to the dollar. Either way, both categories of stable coins benefited from some speculative movement. Several protocols are accessible for users to enjoy returns on their stablecoins. Some Internet users have not hesitated to criticize this system as a "Ponzi" scheme, which consists of paying the interests of investors with the funds of new investors.
As a reminder, stablecoins represent around 10% of the entire cryptocurrency market and weigh a large part of the trade. It is difficult to imagine the cryptocurrency market today without stablecoins. In addition to their qualities of stability, stable coins had a purely utilitarian aspect between individuals or institutions. From now on, stable coins raise the question of their security in the face of crises and, above all, their reliability and sincerity concerning the guarantees presented. Most stablecoins seem to be maintaining their parity, but this crisis has shown that the risk of a total and rapid collapse cannot be ruled out.
Terra Luna: Questioning stablecoins and cryptocurrency in general?
Several days after the collapse of LUNA, the price does not seem to show any signs of a good rebound. However, the UST rose to $0.2 on May 15, but parity at $1 still seems far away. A resurgence of the Terra ecosystem is unlikely, and a return to pre-crisis thresholds, particularly on LUNA, does not seem realistic given the current market environment and market sentiment.
The Terra crisis will remain a historic crisis in the cryptocurrency market, which lost the equivalent of $350 billion in capitalization in 4 days (-23%). In addition, several ecosystems are impacted, such as mining companies. Beyond this example, this raises the question of spreading such crises to the entire cryptocurrency market. In any case, the absence of liquidity in the stock markets for several months, driven by central banks and the macroeconomic context, has revealed inherent weaknesses in cryptocurrencies.