It was the biggest event in recent crypto history: the crash of Terra (LUNA) and TerraUSD (UST). Everyone in the crypto world and beyond was talking about the fallout and the impact on the broader markets. The price of Bitcoin reached a low point, but the cryptocurrency is still being bought by the so-called whales. Time for our monthly tour of the crypto world.
The Luna crash: a quick recap
The crash this month captured the headlines of the financial press, but what exactly happened? The value of Luna – one of the top ten cryptocurrencies by market capitalisation – fell more than 99% in a few days. Meanwhile, the ecosystem’s ‘stablecoin,’ which is designed to hold a steady price of $1, collapsed to $0.30 and ultimately went to zero.
To understand what happened, we need to explain the Terra ecosystem. Terra is a blockchain, similar to Ethereum or Bitcoin. Terra’s main product was a stablecoin called UST, which is pegged to the dollar. Stablecoins are used by crypto investors to protect their capital from volatility without fully cashing out. It’s important to note, however, that UST was different to most other stablecoins because it was ‘algorithmic.’ More on that in a second.
Luna was seen as a good investment over the last year, with the cryptocurrency hitting a high of $116. Meanwhile, UST’s popularity was due to the crypto lending platform Anchor, where traders could earn money by storing and lending their crypto. The outlandish annual yield (APY) of nearly 20% promised by Anchor attracted a lot of interest. About 72% of all Terra investors had their coins with Anchor.
However, the problem here is that UST was an ‘algorithmic’ stablecoin. Most stablecoins in the crypto world, like USDC, are backed by an equal amount of cash or equivalents in reserve. But UST was different. It used an experimental and complex system designed to keep the UST price stable using a balancing mechanism involving its sister Luna cryptocurrency. However, due to the extreme market conditions in May, that balance became impossible to maintain.
First, Do Kwon, co-founder and CEO of Terra, said on Twitter that his company Terraform Labs had withdrawn $150 million UST from Curve (a stablecoins exchange) to prepare for a new “liquidity pool” to go live on the exchange, but at about the same time, an unknown user withdrew roughly $84 million worth of UST and exchanged it for another stablecoin known as USD Coin via Curve.
At the same time, financial markets were dropping around the world due to the central bank’s rate rises. A very large group of UST depositors began to withdraw their stablecoins from Anchor. That wave of trades caused the stable $1 UST to ‘depeg’. You can think of the event as a crypto version of a bank run, where everyone takes their money out of the bank at the same time. And that in turn led to even more UST owners trying to get their money out of it. Since UST and Luna are linked together in the algorithmic balancing act, the massive withdrawals of UST caused a huge increase in Luna’s supply, further decreasing its value.
It became a ‘death spiral’ where both currencies ultimately collapsed.
If you’d like a deeper explanation of the crash, this article from Bloomberg offers a good description.
ECB boss Lagarde calls for more crypto regulation
ECB President Christine Lagarde also reacted to the situation around Terra Luna and argued – not for the first time – for more regulation around crypto. Could the Luna debacle speed up the process of regulation? Incidentally, the ECB is working on its own digital currency, which will be tested from next year. This coin will be linked to the euro.
Bitcoin value also affected by Terra turmoil
The situation surrounding the Terra crash has also hit Bitcoin and Ethereum. The two largest cryptos have lost more than 50% of their value since their all-time highs last November. In addition, Terra had recently bought $3 billion worth of bitcoin for its balance sheet but was forced to sell most of it last month in a last-ditch attempt to save the UST peg. Partly as a result of this, the Bitcoin price reached a new low year-on-year of about $27,000. That was the lowest value since December 2020.
Whales see cheap Bitcoin and keep buying
While many new crypto investors are in shock from the recent moves, the so-called whales are still eager to buy. A whale is a person, company or institution with a large amount of bitcoin or other crypto. These market players have enough buying power to influence the entire market with their portfolios. The recent activity from whales and the growing group of institutional investors show that there is still a lot of confidence in crypto and Bitcoin from the wealthy and specialist corner.
Crypto is volatile, but adoption continues to rise
Investing in crypto has become increasingly popular in recent years, especially among institutional investors who made crypto part of their portfolio. As a result, the number of investments in Bitcoin has increased more than ever since the beginning of 2021.
Traditional investment banks like JP Morgan and Morgan Stanley have begun offering crypto to their clients. Tesla also put Bitcoin on its balance sheet which helped draw attention. Due to this increasing adoption, Bitcoin climbed to an all-time high of about $69,000 in November 2021 and the value of the entire crypto market grew as much as 185% last year to about $3 trillion US dollars. The market capitalisation of all crypto is now worth about $1,277 trillion and Bitcoin stood at about $29,900 on May 22.
Looking ahead to the crypto world in June
Of course, crypto investors will be focused on the aftermath of the Terra Luna and UST debacle. It will be interesting to see what conclusions we can draw as more and more information comes to light. We will of course keep you informed.
Are you ready to deal with this volatility as an investor? Make sure you only invest in crypto with money you can afford to lose. Crypto is still very volatile today, so it’s always a good idea to create a broadly defined portfolio with, for example, stocks and ETFs.
Curious to learn more? Visit our Knowledge Centre to find out more about crypto and investing in general. It’s free so please take advantage of it!
- Not yet
All views, opinions, and analyses in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.