Luna Coin
Luna Coin

When a Stable Coins Collapses: What Happened To Luna?

Recently the crypto market witnessed one of its biggest financial collapses when Luna, The coin of the Terra-LUNA network, collapsed and almost disappeared into thin air. Luna was considered among the top 10 coins in the crypto market in terms of market worth, and went from a rate of 80$ per coin to basically nothing in less than a week. One of the most troubling aspects of this meltdown, was the fact that unlike most crypto coins, Luna was considered a stable Coin, which was meant to prevent precisely this kind of scenario. But what is a stable coin, and what happened with Terra-Luna? Stay tuned.

What is a stable coin?

A stable coin is a crypto coin pegged to the price of a commodity (e.g., gold) or a traditional fiat coin (e.g., US Dollar) to keep its value relatively stable. Stable coins are supposedly a solid alternative for regular crypto coins: Crypto coins are considered highly volatile and can experience significant downfalls in short periods. Assuming that a bona fide and doxxed organization runs the stable coin network, it should be more durable than regular crypto.

The Curious Case of Luna

Besides Luna, two other popular stable coins are USDC and USDT (Tether): These coins are pegged to the dollar and most importantly, backed by a deposit of assets. Unlike them, Luna worked in an entirely different fashion and is considered a ​​Seigniorage-style coin or an algorithmic coin. This is how it works: The Terra project issued two coins: Luna and TerraUSD (or UST). Lunas’ purpose is to support USTs’ stable rate and ensure that it will always be worth one U.S dollar. There is a mutual bond between the coins: UST will always be worth about 1$, and Lunas’ worth will be determined by supply and demand. If the UST falls under the value of 1$, holders can always convert it to a 1$ value of Luna coins. This activity reduces the number of USTs on the market by so-called “burning” them. That way, there are fewer UST coins per Luna, which means the UST is worth more Luna coins. On the other hand, if the UST rate passes the benchmark of 1$, Luna holders can burn their Luna’s and get UST instead. That way, each Luna is worth more (in dollars), and every UST is supported by fewer Luna’s in the system.

Terra Luna crisis
Terra Luna crisis

Another “Great” thing that Terra did is Anchor: Anchor was Terras’ way of getting investors into the ecosystem until Luna and UST had their own independent value. Anchor is a loaning and savings system that offers almost 20% interest on UST deposits that were meant to be used as loans. That is, of course, an insane interest rate, maybe too good to be true (you know what? it is). Why? Because when people can get 20% on your USTs’ that creates a massive demand for USTs’. However, if you remember, the UST  rate is supposed to be pegged to the U.S dollar, which means that the protocol has to burn many Luna coins in order to support the UST. This kind of activity only exacerbates when this burning of Luna coins creates a demand for them in the free market, which creates a vicious circle of debt in Anchor reserves. 

Since Anchor offered such great interest rates, there were a lot of deposits but not enough borrowers. On top of that, over 70% of USTs were held in Anchor. This situation was alarming in real-time before the crash. In early 2022, Do Kwon, Terras’ founder, announced the establishment of the “Luna Foundation Guard,” an organization “mandated to build reserves supporting the $UST peg amid volatile market conditions.” The plan was that LGF would support Lunas’ worth by buying 10 billion dollars worth of BTC (meaning that this algorithmic coin system isn’t sustainable). Other measures made by Do Kwon, such as changing the interest rates, and create demand and liquidity for UST outside Anchor (There were more measures that we won’t get into for now).

The Fall

At the beginning of May, LFG held almost 2 billion dollars in BTC, and the Demand for UST was at an all-time high. Here we reach another factor that caused the meltdown and the absolute icing on top of the shit cake: “The Curve.” The curve is a stable coin liquidity pool that allows arbitrage traders to convert stable coins for a profit. On May 7th, an anonymous investor dumped 85 million UST worth roughly 1$,and traded them for 84.5 million USDC. In hindsight, this was an attack on UST: That move created a flood of UST coins that got into The Curve pool. At that point, more people tried to convert their UST coins into Luna’s since the UST was losing its value. In a twisted dynamic of events that lasted for a few days, LFG tried to stabilize the coins, but in the end, investors lost confidence. Long story short, USTs’ current worth is 6 cents, Lunas’ worth is zero, and 1.2 billion dollars in Bitcoins disappeared from LGFs’ public wallet. There is currently an active prosecution in South Korea regarding Terras’ collapse.  

The moral of the story is? Don’t be tempted by quick and easy money promises, and get in only when you understand what you are doing.

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