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This incident has been by far one of the most interesting, entertaining, but for some also painful and horrific, in months. This was not only because of the significant price falls and dips within crypto markets, but also due to the situation connected to one of the biggest blockchains in the sector, Terra (Luna).
Luna, as well as its stablecoin, TerraUSD (UST), have both lost most of their value in less than a few days due to unprecedented actions and events that took many by surprise. What has happened and what can the crypto community learn from it?
The problems for Terraform Labs and Luna Foundation Guard (LFG) began on Sunday 8th of May, when UST lost its peg and fell down by 2 cents. While this was not something that had the power to destroy the whole ecosystem around Terraform, it definitely gained unwanted attention by a lot of prominent people in the industry.
That is also a reason why LFG decided to allocate more than 1.5 billion dollars in Bitcoin and UST to stabilise the algorithmic stablecoin and bring the peg back to its normal 1 UST = 1 USD parity. This was supposed to be done through various professional market makers, who remained unknown, something that has happened a lot along the way, as we will discuss.
While this initial step helped to bring the peg back to normal, it hardly solved the problem. On the contrary, the problem was exacerbated by other events. One of them came only a day after the initial de-pegging of UST from USD.
On 10th of May, Binance, one of the biggest and most important cryptocurrency exchanges, halted the withdrawals of Luna from the exchange for over 6 hours. The exchange cited problems with network clogging and congestion. While the withdrawals were resumed relatively quickly, this only supported the panic and suspicions of traders and investors of Luna about escalating problems of this cryptocurrency.
This was easily seen through the price of Luna, which lost more than 50% of its value in less than 24 hours. This brought the price below the 30 dollars mark, which represented a huge drawdown from the ATH of Luna of 119 dollars that was created only a few weeks before. Yet, Luna was not able to keep this price and fell down even more, amidst the complete break of UST and its community.
While on Sunday, 8th May, UST lost only 2 cents of its peg, by the end of the week the price of this stablecoin was around 10 cents (0.1 USD). This means that the stablecoin completely lost its peg, as well as its credibility. However, what was even worse for Terraform Labs and Luna Foundation Guard was the fact that Luna was trading even below this price.
Luna lost 99.9 % of its value in that week and is currently trading for a fraction of a fraction of a cent. This was due to the nature of UST and Luna and their relationship, which completely changed the market capitalisation of Luna and changed its supply so drastically that this token completely lost its value.
To put it simply, every time someone tries to change UST for Luna, 1 dollar worth of Luna is given to the trader, while 1 dollar worth of UST is destroyed. The same applies the other way around. That means that if huge amounts of traders want to leave UST and trade it for Luna, and the price of the Luna token is falling, just like it was, more and more of its token needs to be printed.
And this ultimately kept repeating, prices of both the cryptocurrencies kept falling and created what we can call a death spiral. The price of UST and Luna was falling, which meant that more and more people wanted to exit both cryptocurrencies, which meant that the selling pressure would increase the supply of Luna and decrease its price. The demand for both was falling which meant that the peg of algorithmic stablecoin UST was further pushed below, hence leading to a complete collapse.
After all of this has happened, Do Kwon, the main person behind UST and Luna, has tried to find some solution to this situation. The proposed solution would involve creation of one billion tokens that would be distributed with 40% of tokens going to the holders of Luna tokens based on redistribution formula before the de-pegging of UST happened. The next 40% would be distributed to UST holders. 10% would go to Luna hodlers before the whole chain was halted and the remaining 10% would go to Community Pool for the future development of the project.
This plan, however, was not very welcomed by the community. For instance, Changpeng Zhao, CEO of Binance, showed that minting of new tokens would not solve anything. He was critical of the solution proposed by Do Kwon and stated the following:
“Reducing supply should be done via burn, not fork at an old date, and abandon everyone who tried to rescue the coin. I don’t own any LUNA or UST either. Just commenting.”
He was also critical of the transparency, lack of communication and ownership to the situation that was caused by them.
At its prime, UST was the 3rd biggest stablecoin and Terra was one of the biggest cryptocurrencies. In fact, both of these cryptocurrencies were in the TOP 10 for market capitalisation, which means that their sudden demise provides learning points and takeaways for everyone. If such a quick and sharp collapse can happen to cryptocurrencies worth tens of billions of dollars, it can happen to almost any cryptocurrency. Thus, let’s look at the few key factors that this situation provided for anyone who is participating in the crypto world.
One of the key takeaways from this situation is the clear lack of transparency. Do Kwon, the founder and most prominent person behind Luna and UST, was very vocal for most part of the history of Luna. However, once this situation unraveled, Do Kwon was quiet for several days, which is something that did not help the reputation of Luna.
However, what was worse is the fact how Luna handled its stash of bitcoins. Luna Foundation Guard was one of the biggest holders of bitcoins, with over 80,000 BTC in its holdings. Once the de-pegging of UST and price crash of Luna started happening, LFG decided to sell some of its bitcoins. Yet, no one knows whether the whole amount was sold, when or to whom. As of now, LFG only stated that it holds around 300 BTC and some other cryptocurrencies.
This clear lack of transparency with such a huge amount of bitcoins hardly improves the reputation or credibility of this project. Lack of transparency, especially in the cryptocurrency world, is something that the hardcore promoters of Bitcoin and other mainstream cryptocurrencies are very strict about. Thus, lack of transparency is definitely something that cryptocurrency enthusiasts need to take into account when deciding which projects to follow.
Decentralization is just as important as transparency in the crypto world. And, just like transparency, decentralization was missing in this case as well. The sole fact that the team proposed a solution that was not agreed by the community shows that the project is highly centralised and there is no involvement of the community in the governance of the whole project.
This simply means that while this might have been a solid project, which turns out it probably was not, it was definitely not decentralised. Looking ahead, it probably will not be in the future either, if the decisions will be still in the hands of Do Kwon and his friends.
While this article provides a rather long description of the whole situation, it hardly provides a deep-dive to the whole ecosystem connected to Luna and UST. Those are much more complex and it involves several other projects like Anchor, 3pool, 4pool or Curve Finance. And that might be yet another problem that is highlighted by the situation surrounding the Luna crash.
The DeFi world is still complicated and far too dangerous. Hacks, crashes and failures are still very common in the DeFi world, which can lead to significant losses. As it turns out, not even the biggest projects in the crypto world are safe, which only underlines to investors or the traders the importance of exercising caution before investing.
And if they decide to invest, they should do so carefully. The Luna saga has brought yet again attention to many investors, who put more money in this project that they could afford to lose. The forums of Luna and its community were sadly full of horrible stories of people losing hundreds of thousands of dollars.
For instance, KSI, a UK Youtuber lost solely on this movement more than 2.8 million dollars. The value of his holdings of Luna, which was worth 2.8 million dollars at one point, are now worth only less than 1, 000 dollars. This only shows that diversification is still necessary and that no one should ever put too many eggs into one basket.
While this situation can provide tons of learning points for everyone, the value that the investors lost is gone forever. Luna and its stablecoin UST will have an uphill task extremely difficult situation in reviving the lost capital, credibility or reputation. Many believe that this task is almost impossible, but as Do Kwon already highlighted, the team behind Luna will try to do whatever it takes to at least give it a try. But not many believe that Do Kwon should do it. Shibetoshi Nakamoto, the creator of Dogecoin said that that is exactly the opposite of what Do Kwon should do:
“My recommendation is to stop trying to bring in new victims to fund the previous victims and leave the space forever.”