Terra Luna: The Maximum Annihilation

Terra is a decentralized financial payment network that was built with the aim to replace the traditional payment stack with a blockchain token. Do Kwon is the founder of Terraform labs, he is from South Korea and a Stanford University Graduate. Terra UST was the main project in the Terra ecosystem which was a fiat-pegged stable coin. These stable coins are meant to be less volatile than other cryptocurrencies like Bitcoin or Ethereum, which are considered more volatile or subject to a sudden rise or fall. Terra UST was pegged to US Dollars which traced the value of US Dollars algorithmically, and this stabilization was done by buying and selling its reserve currency Terra Luna. Hence, Terra UST served the purpose of offering a stable medium of exchange in the cryptosphere, where 1 Terra UST = $ 1, and this facilitated payments and financial activities through crypto in a smooth manner.

At least, in countries like US, UK, and India, where the crypto tax regime was imposed, stable coins were essential. Crypto Investors and Traders could have squared off their crypto position by swapping them for stable coins whenever they hit their targets or found their investments over-saturated. In these scenarios, stable coins Terra UST and USDTether just did the work decently. Due to their good volumes and liquidity there was almost no impact cost in the transaction, and the stable coins also saved the investors and traders from taxes because profits were not realized yet.

➡️ Terra Luna fundamentally had 3 main objectives:

1) Mine Terra transactions through staking 

(because Terra protocol runs on a Proof of Stake - PoS blockchain)

2) Ensure price stability of Terra UST

3) Incentivise the Terra blockchain validators

➡️ How does Terra actually maintain price stability in Terra UST?

Being an algorithmic stable coin, Terra UST's prices are regulated by an algorithm in the Terra ecosystem by adjusting its supply depending upon the fluctuations in demand. The core objective is to keep the value of one unit of Terra UST equal to one US Dollar. If, 1 Terra UST > 1 US Dollar, then to equate the value the algorithmic programme mints more Terra UST and sells them in the open market. The increase in the liquidity of Terra UST pulls its value and pegs its value back to 1 US Dollar. In the same way, if 1 Terra UST < 1 US Dollar, then the algorithmic programme mints more of Terra Luna and swaps it with Terra UST which pushes the demand and pumps up the value of Terra UST, and this process happens till 1 Terra UST equals $1. So, the protocol is built in such a way that it serves as a market maker for Terra UST and Terra Luna swaps. The exchange of value between both assets maintains stability and mitigates volatility as long as there is a sufficient degree of demand within the Terra ecosystem, whether driven by Terra Luna's value or Terra UST's transactions.

One question that always bothered me.

➡️ Why would people invest and hold Terra Luna if it sacrifices its value to stabilize Terra UST? 

The answer is people's belief in the technology backed by Luna and to receive interest by staking their Luna coins (Investors benefiting in two ways: Asset appreciation and earning fixed ROI on the staked Luna coins).

Terra UST was looked at as a very successful stable coin in the niche of Algorithmic Stable Coins because other algorithmic stable coins had miserably failed in the past.

Fiat-backed stable coins, through a collateralized method maintain a 1:1 peg with the currency they monitor. To support the stable coin's valuation, the coins in circulation are backed by actual assets. Tether (USDT), the most valuable stable coin by market capitalization, is backed by cash (USD) and cash-equivalent bonds held by a bank or other controlled organization, in simple words, after every USDT is minted, the organization puts $1 aside in a reserve as collateral. 

Whereas, the algorithmic stable coins function a bit differently. They usually have no collateral backing and rely on complicated algorithms to keep their peg to the fiat currency they track. These algorithms can also be used to incentivize and control investor behavior in order to keep the coin's price close to the peg. But, practically these protocols haven't seen a triumph in delivering justice to the objective because sometimes volumes in the market are so high towards either of the sides, resulting from speculation, panic or greed makes it harder to mint and swap. This process eventually breaks down. Popular Algorithmic Stable Coin projects like Iron finance's Titanium or the TITAN have crashed awfully, whose current value is zero! The price of TITAN fell from US$64.04 on 16 June 2021, to almost zero (US$0.00000105) on 17 June 2021, in a single day!

The same story is repeated with the Terra!

And on 12th of May was the black day for all the Terra Luna investors as the LUNA price fell by 96% in a day, pushing its value to less than 10 cents. The loss of Terra UST's dollar peg has sent shockwaves through the crypto market, exposing the vulnerability of algorithm-backed stable coins.

➡️ There are various perspectives and stories explaining the downfall of Luna:

1)Charles Hoskinson, who himself is an influential personality in the crypto space, is also the founder of Cardano Blockchain and co-founder of the popular Ethereum Blockchain. And according to Charles, large investment banks have short-sold Terra Luna, (and this version is more like a fictional story).

2) Ruben Merre, founder of Crypto wallet company - NGRAVE alleges the market to be manipulated by some big firms. He has his own version of the story where big firms bought 100K bitcoins and swapped some of them to Terra Luna, and this caused a liquidity choke in Terra UST, after which the companies are blamed to have dumped them into the market, (again unbelievable because there was no price jerks nor volume variation before the downfall).

3) There were also rumors alleging Do Kwon to be one of the pseudonymous co-founders behind the failed algorithmic stable coin Basis Cash which popped up before several days.

4)Finally a more believable angle. Due to rumors that Terra is switching from a fixed rate of 20% interest to a variable rate, substantial quantities of Terra UST were unexpectedly withdrawn from Anchor. Investors became concerned, and they began selling Terra tokens and exchanging them for other stable coins. People had started swapping Terra UST for Terra Luna in large volumes. Terra Luna's supply eventually rose, and its price dropped. The balancing process broke down as more people dumped the Terra UST, and both the Terra UST and Terra Luna coins crashed.

Terra Investors are facing a real hard time because there is no bright side to their investments in the near future. Luna Foundation Group also confirmed it depleted its Bitcoin reserves from around 80,000 bitcoins to 313 bitcoins during the attempt to save Terra UST’s peg.

In order to preserve the community and the developer ecosystem, Do Kwon has proposed resetting the distribution of the network’s Luna tokens and also proposed a revival plan, but this doesn't boost investors confidence as of now.

➡️ Currently, the entire crypto market now has a market capitalization of $1.2 trillion, less than half of the $2.9 trillion it was worth in November 2021. 

Following the massive loss experienced by investors, numerous crypto exchanges, including Binance and Coinbase, have blacklisted Terra UST and Terra Luna.

The deep plunge in Terra Luna's value has impacted the entire cryptosphere, even the big daddies Bitcoin and Ethereum have lost 5% and 15% respectively, in the last fortnight.