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The LUNA-Tic Descent of Terra: Its Causes and Impact on the Crypto Market

by Gideon AleonogweDecember 15th, 2022

Too Long; Didn't Read

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Terra has received aggressive backlash, press coverage, and rebranding over the last six months. What precipitated the fall of one of crypto’s most valuable assets? What impact has its slump had on the market?

Terra always had it coming…

Terra’s (now Terra Classic) problems may have begun on May 7th, but it always looked primed to fall off. The network’s stablecoin, UST, was backed by LUNA and a set of programs designed to even out the latter’s volatility and bring the former’s price back to $1.

But the algorithms could only do so much to even out LUNA’s price valuation reduction from $85.5 to 50 cents.

Experts attribute the crash to two UST trades that happened on the night of May 7th. Terraform Labs, the creators of UST attempted to move 150 million UST from 3pool elsewhere.

This created a volatility window on the decentralized exchange exploited by two traders who swapped just under 200 million UST for USDC. Panic broke out due to these trades, which resulted in other investors swapping for safer stablecoins and cryptocurrencies to mitigate their loss. In a last-ditch effort to even out the ratio of UST to other stablecoins, Terraform withdrew 100 million UST more. But this failed to re-peg UST.

A proposal submitted on May 11 by Terraform Labs CEO Do Kwon revealed that the algorithms needed to overcompensate for the market speed to reinstate the peg. He proposed an alteration of the underlying code that meant more LUNA minting and worsening hyperinflation of the asset class.

The LUNA-cy became contagious

The LUNA-UST panic soon caught up with the whole market and set the market on a losing spree. LUNA’s “sudden demise” made investors realize that “anything can happen” and earmarked massive cryptocurrency exchanges.

Two of the biggest cryptocurrencies, Bitcoin and Ethereum, suffered losses in excess of 60% and 30%, respectively.

This overarching red of losses by investors increased the calls and pressure for the regulation of cryptocurrencies. United States Treasury Secretary, Janet Yellen, reinstated the desire to push for stablecoin regulation during a Senate Bank Committee hearing while traders fought to stay afloat.

She said:

[With stablecoins,] we see run risks which could threaten financial stability — risks associated with a payment system and its integrity and risks associated with increased concentration if stablecoins are issued by firms that already have substantial market power. We definitely see significant risks here.