The downfall of LUNA shook the crypto world. With most cryptocurrencies plunging more than 50%, billions of dollars have gone into thin air. Fear and uncertainty have taken the place of confidence as noticeable in the investment behaviour in the cryptocurrency market. How could this meltdown happen and what are the consequences?
The cryptocurrency LUNA is associated with TerraUSD (UST). UST is a stablecoin which entails that there is an algorithmic $1 peg governed by underlying code. UST is inherently different from the other stablecoins like Tether and USD which are both backed by real-world assets such as bonds. UST has no real-world assets are merely relies on the algorithm. To maintain the $1 peg, the UST algorithm stabilises to create and burn tokens of both UST and the linked crypto LUNA. However, due to the extreme market volatility, UST has been unable to maintain the peg and dropped to 12 cents according to data from CoinGecko. Further, the Terra blockchain, which is the operating chain for UST and LUNA, had problems processing transactions twice in less than 24 hours.
Due to the inability to maintain the peg, LUNA plunged to $0 from more than $100 in the last months. This decline in price in UST – and therefore LUNA- has resulted in a meltdown in the crypto market. Even while the collapse of UST only lasted for several hours to regain the $1 peg, billions of dollars in value have been erased and the largest cryptocurrency bitcoin dropped 15% for the week, a level not seen since late 2020.
Bitvavo, a big trading platform, compensates investors after this disaster. The prices are equal to the prices of the pause on 13-05-2022 at 8:20. This pause was needed to create a plan to further stop the devaluation of the stable coin. Binance, the world’s largest crypto exchange temporarily delisted UST and LUNA but reversed this decision after Terra announced resuming new verifications on the blockchain and halting direct transfers.
The LUNA / UST situation resulted in panic and insecurity in the crypto market. In combination with the higher inflation and interest rates that have caused a sell-off in the global stock market, the cryptocurrency market seems to be related to the stock markets and manifests in a loss of more than 50% value in most cryptocurrencies. The growing fear and growing levels of inflation decrease the trust and investment in the crypto market. According to Vijiay Ayyar, the vice president of corporate development and international at crypto exchange Luno, in the crypto market «it’s normal to see bounces amounting to 10-30%».» While «these are normally bear market bounces, testing previous support levels as resistance», even the largest of cryptocurrencies such as bitcoin may not be sustainable or be able to bounce back. As To long-term feasibility of cryptocurrency needs to be further explored — focussing on the environmental impact of the mining of these coins.
Cryptocurrencies as investments bring the known risks of (heavy) value fluctuation. However, as seen in the LUNA case study, the value of your assets can rapidly drop to a point of no return. KSI, a well-known Youtube, lost $2.8 million in his LUNA investment making his coins virtually worthless.
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