When Terra Luna launched their UST stablecoin in late 2020, it was billed as a game-changer that would revolutionize the payments and cryptocurrency. And it was – until it crashed and burned just a couple of years later in May 2022. What happened? And what lessons should we take away from it? Here’s what blockchain technology providers have to say.
What is Terra Luna and UST?
Like blockchain technology providers Ethereum and Bitcoin, Terra is its own blockchain. The UST stablecoin is Terra’s foremost product and is pegged to the US dollar.
Here’s how Terra’s UST was supposed to work:
Stablecoins are “stable” because they pegged to the reserves of another asset, like the US dollar.
- As a result, these stablecoins aren’t as volatile as other cryptocurrencies.
- This makes them attractive for use in payments and financial contracts. This also technically makes them a safer investment than other cryptocurrencies.
On the other hand, Terra’s UST is an algorithmic stablecoin.
- Algorithmic stablecoins don’t derive their value from being backed by reserves or fiat currencies.
- Instead, UST’s value is algorithmically linked to Terra’s native currency, Luna.
- How that’s supposed to work is that when the price of Luna goes up, so does the price of UST.
- The idea is that because Luna is a stablecoin itself, it would help to keep UST’s price stable.
- In other words, if there’s a run on UST, the Luna algorithm would print more UST and buy up Luna until the price stabilized.
This system would theoretically be self-regulating and wouldn’t require human intervention or reserves. So what went wrong?
How Terra Luna’s UST Stablecoin Crashed
The problems with UST began to surface with Anchor, a lending platform that offered investors interest rates as high as 20% to buy and lend UST.
This attracted a lot of investment into UST, driving up the price. Wealthy investors began borrowing large amounts of Bitcoin to buy UST in what’s known as a “short selling.”
The idea behind short selling is that you borrow an asset, sell it, and hope the price falls so you can buy it back at a lower price and give it back to the person you borrowed it from. If the price falls like you expect, you make a profit. If the price doesn’t fall, you lose money.
In the case of UST, the price didn’t just fall – it forced UST to depeg from the dollar, aka “crash.” Keep in mind that the power of stablecoins lies in the fact that they’re pegged to the dollar (or another asset). When they “depeg,” it means they’re no longer backed by the dollar, and their value plummets. This is exactly what happened to UST and spread like wildfire through cryptocurrency news outlets.
When UST depegged from the US dollar, investors who reaped interest through their Anchor loans began to panic. They started pulling their money out of UST, causing a domino effect that crashed the price of Luna as well.
The result is that Luna, which was valued as high as $116 in April 2022, is now worth less than a penny. UST is currently worth just a few cents.
The effects were staggering: many Luna and Terra investors lost their lifesavings, and the crash pulled down the rest of the cryptocurrency market with it.
Keep Your Faith in Crypto & Build Your Wealth
Despite the Terra Luna debacle, there are plenty of reasons to believe in the future of cryptocurrency. The truth is, no investment is risk-free – even fiat currencies can lose their value and become worthless overnight.
What’s important is to diversify your investments and study your risk appetite, the market, and all other factors that can affect your investments. It’s also important to have realistic expectations about what the crypto market can do for you.
The cryptocurrency market is still in its infancy, and there will undoubtedly be more ups and downs to come. But for those who are willing to weather the storm, the rewards will be amazing. So don’t lose faith in crypto – it’s here to stay.
In the meantime, our cryptocurrency asset managers here at Key Coin Assets are ready to answer all of your questions about investing in cryptocurrency safely, profitably, and for the long term. Contact us today to schedule a chat with our digital asset management specialists today.