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Crypto market in turmoil: Terra crash sends wide shock waves

Crypto market in turmoil: Terra crash sends wide shock waves
Written by insideindyhomes

Algorithmic stablecoin Terra has slipped below $0.20 at times
Terra LUNA coins have become virtually worthless – $25 billion burned
Terra disaster worsens crypto sentiment

Terra USD (UST), one of the most used stablecoins in the world alongside Tether and USD Coin, has experienced drama in the past few days. Meanwhile, the Terra blockchain at block 7603700 has been decommissioned “to prevent attacks,” the developer behind it, Terraform Labs, tweeted. The impact of the crash was not limited to UST and its sister coin LUNA, issued by the same project, but affected the entire crypto market. How did Terra’s price collapse come about? And what does this mean for the future of stablecoins?

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Terra stablecoins intermittently fall below $0.3

On May 9, there were increasing signs that Terra could no longer hold the parity with the US dollar. The Terra started trading May 10 at $0.88 – quite a significant loss for a stablecoin that is aiming for a steady 1:1 parity against the US dollar. But it got much worse: the UST is currently trading at $0.145 (as of May 13, 2022). In concrete terms, there is hyperinflation behind it: the amount of LUNA coins in circulation increased rapidly, after which the price fell, as “t3n” explains. Market observers spoke of a veritable “bank run”: Terra investors tried to save what could still be saved. The crypto exchange Binance had to temporarily restrict trading in UST and LUNA due to the high number of outstanding sales requests, as “CNBC” reports.

The entire crypto market is suffering from this drama, with Bitcoin temporarily dipping below the US$ 27,000 mark for the first time since December 2020. The cryptocurrency LUNA, which was also founded by the Terra company, has lost over 99 percent and is now worthless: A LUNA currently only costs 0.0008837 US dollars (as of May 13, 2022), while in April 2021 it was temporarily still had to pay over 115 US dollars. Thus, a fortune of around 25 billion US dollars – according to “Coinmarketcap” the market capitalization of the Terra-Coins LUNA immediately before the start of the sale on May 7th – disappeared into thin air. Add to that the nearly $19 million that the UST was previously worth.

How does the Terra stablecoin work – in theory?

Unlike the two most well-known stablecoins in the world, Tether and USD Coin, Terra does not have any financial reserves backing the token. Rather, Terra uses an algorithm maintained by development company Terraform Labs to replicate courses. Terraform Labs was founded by Do Kwon in Singapore in 2018. The price should remain constant by reducing or expanding the supply for the US dollar depending on the point in time by buying and selling UST and Luna. So behind Terra there are no real dollars, but cryptocurrencies – in the case of the UST this is the LUNA. A UST is therefore always equivalent to a dollar in LUNA. Owners can always “burn” $1 worth of stablecoins and “mine” LUNA of the same value at a fixed exchange rate in an arbitrage deal, as Capital explains. For example, the supply of UST tokens can be tightened, causing price inflation and maintaining parity with the US dollar.

Terra depended on investor confidence – now that’s gone

At least in theory – in practice, however, stablecoins that work via algorithms have major deficits, as the Terra disaster underlines. “It’s a catastrophe, but one that was to be expected. No algorithmic stablecoin has ever succeeded and this is no exception,” Nic Carter, co-founder of Coin Metrics, told CNBC about the situation. Terra’s problem, Carter says, is its lack of financial backing: “Terra isn’t guaranteed, it’s definitely not backed by reserves. It was just really backed by faith in the publisher.” But the Terra stablecoin lost investor confidence – and crashed as a result. Consequently, the LUNA coin linked to it was also discarded, and a dramatic vicious circle set in: The LUNA coins could no longer enable parity with the Terra stablecoin, since they also lost value.

Bitcoin & Co. are suffering from the drama surrounding Terra

Terra’s futile efforts to literally stabilize the stablecoin have serious consequences for the entire crypto sector. The Terra debacle noticeably worsened crypto sentiment. Bitcoin has slid heavily over the past few days. Other major cyber currencies such as Ether, Ripple (XRP), Dogecoin and Cardano also buckled noticeably. Even the stablecoin Tether, which is usually quoted constantly, lost in places to 0.95 US dollars.

Carter on the crypto crisis: “I think the market is expecting some forced sales from Terra here” – forced sales, which at least in part have already happened. According to information from “CNBC”, numerous analyzes pointed to the now empty crypto wallet of the “Luna Foundation Group”.

However, the Terra drama came at the wrong time: Like other risky assets, cryptocurrencies are suffering particularly from the galloping inflation and the associated interest rate hikes by the US Federal Reserve. All of this makes for a toxic cocktail that is likely to remain the dominant theme in the crypto space for the coming days.

Editorial office finanzen.net

Image sources: Chinnapong / Shutterstock.com



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