- When the Luna crypto network collapsed, it was estimated that $60 billion was wiped out from the digital currency space.
- Algorithmic stablecoins (UST) are not unlike Tether or the US dollar, which are backed by physical dollars or assets stored in a bank.
- An arrest warrant has been issued for Do Kwon, co-founder of Terraform Labs, where sisters Luna and TerraUSD have been detained.
Terra Network and its leader, Do Kwon, rose to prominence in the cryptocurrency world over the course of four years, all ending in a disastrous fall from grace. The Luna crypto network has collapsed in what is considered the largest crypto crash ever, with an estimated $60 billion wiped out, shaking the global cryptocurrency market.
There are two stories regarding the Luna cryptocurrency: TerraUSD/UST stablecoin and the actual Luna coin. Once Luna and UST collapsed, there was a full-blown cryptocurrency liquidity crisis that caused an even more catastrophic loss of value. The crypto community still has not recovered.
To understand what happened, let’s review what happened step by step.
What exactly is Luna coding?
You may have heard of TerraUSD and Luna, here’s a quick breakdown of what exactly they are. Lots of moving parts inside Luna’s grid before it collapses.
TerraUSD (also known as UST) and Luna are two sister currencies on the same network.
Terra is a blockchain network, similar to Ethereum or Bitcoin, that produces Luna tokens. The network was created in 2018 by Do Kwon and Daniel Shin of Terraform Labs.
Terraform Labs created the Terra-Treasury Coin as an algorithmic stablecoin on the Terra Network. While other stablecoins (USDC or Tether) are backed by securities, treasuries will not be backed by real assets. Instead, the value of the floor cabinets will be supported by its sister symbol, Luna. More on that later.
Stable coins are supposed to be safe havens in the crypto space since they are supposed to have a fixed value of around $1. The goal is a stable store of value for investors, unlike other volatile coins (such as Ethereum).
Luna was Terra’s original blockchain token, similar to how Ether is used on the Ethereum network. Luna had four different roles in the Terra Network:
- A way to pay transaction fees in the Terra network.
- Mechanism to maintain the stable Terra peg.
- Quota in Terra Delegated Proof of Stake (DPoS) to validate network transactions.
- Participate in the governance of the platform by adding and voting on proposals when it comes to changes in the Terra Network.
How much was Luna worth?
The Luna coin was around $116 in April and ended up falling to a fraction of a penny before it was crossed off the list. Prior to that, the value of the coin went from less than a dollar in early 2021 to creating several crypto-millionaires within a year. This has positioned Kwon as a cult hero among (some) retail crypto investors. Several success stories appeared in the media about how ordinary people were able to get rich from Luna.
The Luna token rose about 135% in less than two months until its peak in April 2022. The biggest incentive was that you could share your terrestrial treasury holdings on the Anchor lending platform with an annual return of 20%. Many analysts felt this ridiculous rate was unsustainable.
The Anchor Protocol was a decentralized cash market built on the Terra blockchain. This platform has become famous for its aforementioned 20% return for floor holders who deposit their tokens on the platform. Then Anchor turns around and lends the deposit to another investor. Many skeptics were concerned about the source of the money to pay these prices. Some considered this an obvious Ponzi scheme. At one point, up to 72% of the ground tanks were deposited in Anchor because the platform was the primary driver of demand for the Terra.
What happened to UST?
Before we look at the crypto catastrophe, we need to briefly discuss stablecoins. A stablecoin is pegged to a more stable currency such as the US dollar. Both Tether and USDC are pegged to the US dollar. Stable coins are used to hedge against fluctuations in the crypto space. For example, let’s say the price of Ether is $1,000. You can exchange 1 Ether for 1,000 USD. When investors anticipate success in the cryptocurrency market, they put their money into stablecoins to protect their assets.
The UST coin was not backed by a real US dollar, but rather an algorithmic stablecoin. The belief was that Terraform Labs could use smart mechanisms along with billions of bitcoin reserves to maintain a peg to terrestrial treasuries without the support of the US dollar.
To create the floor cabinets, you have to burn a luna. So, for example, when Luna token’s price was $85, you could trade 1 token for 85 UST. This contraction protocol is designed to ensure that there is long-term growth for Luna.
In order for the floor cabinets to keep their hooks, 1 floor cabinets can be changed for $1 from Luna at any time. If the floor cabinets slip, traders can make money buying the floor cabinets and then exchange them for Luna.
Luna and UST crashed once UST lost its peg to the dollar, which made it a stablecoin.
TerraUSD was risky because it was not backed by cash, Treasuries or other traditional assets like the popular Tether. The stability of the terrestrial reservoirs was derived from algorithms that associated the value with Luna. Many experts were skeptical that the algorithm could maintain the stability of two symbols.
Why did my LUNA crash?
The reason for the collapse of Luna coin was its connection with TerraUSD (UST), the Terra Network’s computational stablecoin.
On May 7, over $2 billion worth of underground reservoirs were dismantled (removed from the anchor protocol), and hundreds of millions of them were quickly liquidated. There is controversy as to whether this occurred in response to higher interest rates or if it was a malicious attack on the Terra blockchain. The heavy selling brought the price of the floor cabinets down to $0.91 from $1. As a result, dealers began changing floor cabinets by 90 cents for a dollar from Luna.
As soon as a large amount of ground tanks were emptied, the stablecoin began to de-circulate. In a panic, more people sold the floor cabinets, minting more Luna and increasing the circulating supply of Luna.
After this crash, cryptocurrency exchanges began deleting the Luna and UST pairs. Long story short, Luna was abandoned because she had become worthless.
What happened after Luna crash?
The Luna crash affected the entire cryptocurrency market, which was already very volatile and struggling at the time. It is estimated that the collapse of Luna ended up lowering the price of Bitcoin and causing an estimated $300 billion loss in value across the entire cryptocurrency space.
Crypto leaders Voyager and Celsius have filed for bankruptcy. Three Arrows Capital (3AC) has been forced into liquidation.
Many people lost their life savings and experienced financial hardship due to the collapse of the Luna cryptocurrency. If you do a quick search online, you will find many such terrible stories. Many loyal fans of Luna (who referred to themselves as “Lunatics”) have taken to Reddit threads to share their disastrous stories. One retail cryptocurrency investor even admitted that they lost their $20,000 savings in Luna.
The only winners are those who got out of their positions before the crash. The only winner we should highlight is the hedge fund Pantera Capital. They saw a 100x return on an initial investment of $1.7 million. The company liquidated its Luna position before the collapse for $171 million.
What happened to the founder of Luna Crypto?
Do Kwon shared Luna’s recovery plan, and things looked promising for a brief period of time in May after the original meltdown. But the currency eventually fell. It was immediately abandoned. Terra ended up launching a new currency, Luna 2.0.
On September 15, it was announced that a South Korean court had issued an arrest warrant for Do Kwon. This came about four months after the collapse of Luna and UST, the two signature tokens released by Terraform Labs. Do Kwon and five other people are currently charged with violating local market laws.
South Korean officials are seeking to revoke Kwon’s passport because they believe he is currently residing in Singapore. In theory, if this legal action is implemented, Kwon will have to return to South Korea within 14 days of receiving the cancellation notice. The Ministry is currently evaluating the request.
Some investors who lost money in Luna filed a complaint with local prosecutors alleging that Kwon was involved in fraud and illegal fundraising. It is estimated that about 280,000 people in South Korea have invested money in Luna.
How should you invest?
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If you are going to invest in digital currency and other particularly volatile assets, you have to accept that there will be some significant risks associated with it. Hopefully, this disastrous Luna meltdown is more of a swift, black swan event than the start of an era. The main takeaway should be that if an investment sounds too good to be true, it usually does. Second, for investors who remain bullish on cryptocurrencies in the long-term, it would be wise to limit these investments to 5-10% of an individual’s portfolio.
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