An epic thunder broke out in the currency circle. Whether you pay attention to digital currency or Web3, you must have heard about the collapse of Luna. This article will take you through a comprehensive review of the Luna crash event and reveal the truth behind this digital currency experiment.
Luna's collapse
Luna, a digital currency that once had a market value of US$41 billion and was sought after by hundreds of thousands of people overseas, suddenly plummeted continuously without warning. In just a few days, the price dropped from nearly US$90 per coin to less than US$0.00015 per coin today. Tens of billions of assets were instantly wiped out, and those who kept adding to their positions during the plunge ended up losing everything.
Such a tragic crash is very rare in the entire financial market. Luna not only caused a major earthquake in the currency circle and created a spectacular scene of hundreds of coins falling, but also broke through the circle and became the headlines of hot searches in various countries, attracting widespread attention.
The chain reaction after the crash
As of May 19, Luna prices are still hovering at low levels. Recently, the truth about this stablecoin that is full of "Ponzi scheme" has been revealed bit by bit. The process of institutions "hunting" Luna has gradually become clear, and a series of subsequent chain reactions have also begun to appear.
Algorithmic Stablecoin and Terra Ecology: Although many people have seen the news of Luna’s plunge, most people only have a general understanding of Luna as a digital currency, and actually have only a partial understanding of its value operation mechanism. To understand Luna, you must first understand what an algorithmic stablecoin is and the Terra ecosystem in which Luna exists.
Algorithmic Stablecoin with Foot on the Air
For ordinary people, "collapse again" may be the three most commonly heard words about digital currency. Faced with such frequent violent fluctuations, some people began to wonder, is it possible to have a digital currency that can easily convert transactions in the digital world while avoiding fluctuations?
So the idea of stablecoins was born. In 2014, Tether, a subsidiary of the digital currency exchange Bifinex, issued USDT, the world's first stable currency, which was pegged to the U.S. dollar at 1:1. In addition to USDT, the stable currency USDC issued by Coinbase and Circle in 2018 also exists in this way.
But as time went by, many people began to wonder whether this 1:1 mortgage model was too old-fashioned and un-Web3-friendly. Could it be possible to increase the price of digital currency without spending dollars or relying on a central institution? What about maintaining stability?
Then, the currency circle came up with two new ways to play, and two stable coins that sounded unstable were born. One is to change the collateral assets from US dollars to mainstream cryptocurrencies such as Bitcoin and Ethereum. Since these cryptocurrencies are much riskier than the US dollar, more collateral is set up as a guarantee. Another more advanced gameplay is to rely entirely on algorithms to adjust the supply and demand relationship to create and maintain currency value.
The latter is called an algorithmic stablecoin and is not backed by any real assets. Previously, the largest and most mainstream algorithmic stablecoin system on the market was Terra where Luna is located.
Play "White Wolf with Empty Gloves" until you fly Terra
The logic of algorithmic stablecoins sounds very unscientific. How can a digital currency have a stable value out of thin air? The answer is simple. As long as there are enough tricks and you can fool people into taking over, there is value.
Around 2018, Do Kwon, a Korean who graduated from Stanford University with a computer science degree, established Terra, a public chain ecosystem around stablecoins. On this chain, a variety of stablecoins anchored to legal currencies were issued, including those anchored to the U.S. dollar. UST, KRT anchored to the Korean won, etc., among which UST is the largest. The most important thing is that he "expanded his imagination" to design a "seesaw"-like mechanism to maintain the prices of these stablecoins.
Both ends of this seesaw involve two entities: one is Luna, the token on the Terra ecosystem, and the other is the stable currency (represented by UST) that exists on the Terra chain. So, how to play the game?
This game has several rules:
One UST = Luna worth 1 USD. This means that if the Luna price is 1 USD, you can exchange it for one UST. If the Luna price rises to 100 USD, you can exchange it for 100 USTs.
UST and Luna have a "two-way destruction and casting" relationship. Meaning, when you exchange Luna for UST, there is one dollar less Luna and one more UST on the market, and when you exchange UST for Luna, there is one less UST on the market. The supply increases and the price decreases. The supply decreases and the price increases.
UST is minted by Luna, and Luna’s planned coin issuance limit is 1 billion.
How can supply and demand remain stable during this process? Because the small fluctuations in UST prices give this mechanism room for arbitrage.
As mentioned before, 1 US dollar of Luna is always equal to 1 UST. So when UST is higher than 1 US dollar (such as 1.1 US dollars), someone will naturally destroy their Luna in exchange for UST and sell UST on the market, causing the UST price to fall back to 1 US dollar. Similarly, when UST is lower than 1 USD (such as 0.9 USD), someone will exchange UST for Luna and sell Luna on the market, causing the UST price to rise back to 1 USD.
Reasons for the crash
Luna's collapse was not an accident, but the result of a combination of factors. First of all, algorithmic stablecoins themselves carry huge risks because they are not backed by any real assets and rely entirely on market confidence to maintain prices. Once market confidence collapses, prices can fall rapidly.
Secondly, Luna's collapse was also related to its overexpansion. In order to attract more users, Terra continues to launch new stablecoins and attract investors through high yields. However, these high yields were not sustainable and eventually led to a market collapse.
Finally, Luna’s collapse was also related to the “hunting” of institutions. Some institutions took advantage of the instability in the market and sold Luna on a large scale, further exacerbating market panic and causing prices to plummet.
Conclusion
Luna’s collapse once again reminds us that the digital currency market is full of risks and investors need to remain vigilant. In the future, with the development of technology and strengthening of supervision, the digital currency market may gradually become more stable and mature. However, until then, investors still need to exercise caution to avoid suffering huge losses amid market fluctuations.