The thunderous collapse of terra luna : what happened !
The thunderous collapse of terra luna : what happened !

Over the past few days, cryptocurrency trading enthusiasts have come to terms with the sharp jolt that the precipitous drop of the stablecoin TerraUSD (UST) and its sister currency Terra Luna has provided the market. Other tokens and Bitcoin itself also lost ground.

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Some commentators have likened this situation to the financial collapse that stock exchanges faced in 2008 following the failure of the investment bank Lehman Brothers.

Investors in cryptocurrencies, once aggressively bullish, are panicking. Some social networks have even begun offering support to cryptocurrency holders discussing suicide on their platforms.

Terra Luna, which was once among the top cryptocurrencies in the world, began to falter in early May 2022, with many investors selling their coins to limit their losses. The collapse triggered a downward spiral similar to a bank run, rendering the cryptocurrency worthless.

TerraUSD is a stablecoin linked to the dollar

A stablecoin is a cryptocurrency designed to be pegged to another asset, such as fiat currencies. These digital currencies can experience sudden and abrupt fluctuations over  a single trading day.

Stablecoins act as a link to the traditional financial system, acting as a currency with a more testable value.

TerraUSD uses complex algorithms to maintain its peg to the dollar

The thunderous collapse of terra luna : what happened !
The thunderous collapse of terra luna : what happened !

TerraUSD attempts to maintain the same value as the U.S. dollar by using a complex swing mechanism with a related cryptocurrency, Terra Luna (or simply Luna). While 1 TerraUSD should always be worth exactly 1 Dollar, the value of Luna can fluctuate.

In essence, TerraUSD uses Luna as a counterweight to maintain its peg to the dollar. One burns, or destroys, TerraUSD to coin, or create, Luna, and vice versa. Burning a TerraUSD always yields a Luna dollar, and burning a Luna dollar always yields a TerraUSD.

If the value of TerraUSD were to decrease slightly to $0.99

Since it is always possible to trade 1 TerraUSD for 1 Moon Dollar, investors will immediately take the opportunity to buy something worth $1 for 99 cents, making a small profit of 1 cent. They then burn their TerraUSD to mint Luna and get a margin.

The supply of TerraUSD consequently decreases and its price increases to the value of $1.

If, on the other hand, the price of 1 TerraUSD rises to $1.01, Luna holders will burn their coins to obtain TerraUSD and the associated one-cent margin.

The supply of TerraUSD increases and its price falls until it reaches $1

The system broke down on May 8, when 2 billion UST dollars were mined at once and hundreds of millions were sold. USTs fell to 98 cents and the UST exchange mechanism with Luna could not keep up.

This caused investors to lose confidence in the system and both UST and Luna collapsed.

Currently, UST is trading at 12 cents, just over a tenth of its expected value, and Luna at about a 50th of a cent.

More than $15 billion in cryptocurrency has been wiped out by the collapse

The thunderous collapse of terra luna : what happened !
The thunderous collapse of terra luna : what happened !

Do Kwon, the CEO of Terraform Labs, proposed on May 16, Monday, the creation of a new blockchain modeled on the previous one, with some key changes. The new blockchain would be created along with a billion moon tokens, which would be distributed among current holders of sister currencies, as well as fund the development of new Terra apps. This change is called a bifurcation or fork.

The creation of one billion Luna tokens would be a reset for this cryptocurrency, which is struggling with hyperinflation: there are currently more than 6.5 billion luna tokens in circulation, up from 343 million in the week before the collapse.

The inflation is caused by owners exchanging billions of USTs for Luna so that they could be sold into Ether or exchanged for an effectively stable stablecoin, causing a glut of new coinage.

Kwon proposed removing USTs, previously the main strength of the blockchain, from the Terra ecosystem

Perhaps in doing so, he admitted the fundamental problem with tying Luna to UST: "Terra's app ecosystem contains hundreds of developers working on everything from DeFi to fungible labor markets to state-of-the-art infrastructure and community expertise," he said, proposing to preserve it at the expense of terraUSD.

Such a move has a precedent

The most famous fork in cryptocurrency history occurred on Ethereum in 2016. After a hacker stole 3.6 million ethers from a DAO-which at the time was worth $50 million, today it is worth nearly $8 billion-Ethereum developers forked the blockchain, creating a new chain identical in all but restoring the stolen million ethers.

This caused a rift within the community. Indeed, some investors have maintained the original chain to this day, calling it Ethereum Classic.

Kwon's plan is inspired by the Ethereum fork, and the proposal will see the current collapsed crypto blockchain renamed  Terra Classic, while the new chain will simply be called Terra.

read more: how to trade cryptocurrency for beginners 2022

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