The Terra Luna Crash is a Warning for Investors to Keep their Eyes Open

When people first start getting into investing in the crypto scene, it usually begins with BTC or ETH. And the wild rollercoaster of market prices reaching new highs and then dipping into depressing lows is both the reason some people get hooked while others swear to never touch it again. Stablecoins, however, offer investors a seemingly safe, low-risk way to earn passive income with high APY—an alternative way to look at crypto investing, one that is profitable and stable, might as well call it a money glitch!

At least that was the narrative for a little while among crypto bros and Redditors, and posts like these would get a lot of interactions, some of which go along the lines of “banks are scams, better to put all your money into stablecoins”.

Don’t get me wrong, earning passive income from stablecoins is 100% a legitimate option, but treating them as the new banks is such an extremist viewpoint. And if there’s one good thing to come out of the massive Terra Luna crash, I’m glad it has made people open their eyes to the risks in this ‘low-risk’ investment.

What Are Stablecoins and Why Invest in Them?

If you’re late to the party, let’s touch upon the basics of stablecoins real quick. Stablecoins are crypto-assets that are designed to maintain a stable market price, usually pegged to a fiat asset like the US dollar. They have a few ways to achieve this purpose, the most common of which is to have the stablecoins backed by a reserve pool which can consist of fiat or other crypto-assets.

There are other more experimental stablecoins that maintain their stability by using algorithms and smart contracts. Terra, or UST, is one of such stablecoins, and we’ll dive deeper into how it works later.

So what really makes stablecoins an attractive instrument for earning passive income? Well, consider this: the interest rate for banks is very limited, specifically falling around 0.06% APY in America according to the Federal Deposit Insurance Corporation. Even the best rate you can find out there would fall in the range of 0.7%. In contrast, the annual yield rate one can get from stablecoins can be up to 12%. And it’s the icing on the cake that stablecoins’ value is likely to remain, you know, stable.

The Terra-Luna Crash

Back in May 2022, the whole crypto market suffered a severe crash which was a result of the stablecoin TerraUSD (UST) losing its peg to the US dollar. Terra is an algorithmic stablecoin, using a series of smart contracts to maintain its value. It does this by having its volatile counterpart Luna acting as a balancing mechanism, which is automatically bought or sold to adjust the supply of UST.

The whole crash began when one or two arbitrageurs bought a massive amount of UST with Bitcoin, then dumped it on the market. This was done on a low-liquidity weekend on Anchor Protocol when LUNA was most vulnerable. Many people suspected this act to be a planned attack by a hedge fund, but nobody really knows for sure.

The massive trade created selling pressure of LUNA, so the Luna Foundation Guard had to sell all of its reserve assets to recover the value of UST. But this effort was unsuccessful and the whole Terra chain was still experiencing a liquidity crisis. On top of that, people were panic selling their USDT and LUNA, causing LUNA’s price to go from $86 to $0 in 10 days. Thus, UST also loses all its value.

The Terra-Lunar crash is widely considered one of the biggest disasters in cryptocurrencies’ history. Public figures like the YouTuber KSI got his 2.8 million investment turned into $1,000 before he could react, and many normal everyday people who either invested in LUNA or held UST to earn passive income had their lives ruined.

The Lesson Learned: No Investment Is Without Risk

The Terra-Luna crash really made people reconsider their definition of ‘stablecoins’, perhaps even unjustifiably so as there are many other stablecoins that utilize a completely different method to maintain their pegged value. But those who used to see stablecoins as a safe haven to dump all their money into for that sweet APY percentage should have realized by now that there are many other risks involved in it.

For instance, a popular method to earn passive income is to deposit stablecoins into a lending exchange. However, the liquidity in these lending platforms is frequently loaned out on a large scale, so when there is a market crash such as this one, it’s totally possible that some parties are incapable of paying back.

Other risks include cyber hacks targeted at a personal account or a lending platform. With regards to personal accounts, it goes without saying that the responsibility lies solely on the individual to protect themselves. Using different email addresses for different platforms, strong passwords and 2FAs are recommended. Attacks that aim at the lending platforms, on the other hand, are way out of any individual’s control. This alone should be a good reason to not put all your eggs into stablecoins because most lending platforms don’t have insurance coverage.

This is not to say that stablecoins are bad and you shouldn’t invest in them. But don’t make the mistake of seeing stablecoins as a separate entity from the crypto world unbothered by its rules and chaos. No investment is without risk, only invest what you’re prepared to lose!