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Home Global Economy What is Behind the Terra Luna Cryptocurrency Crash: The End of the Crypto Market?
Global Economy

What is Behind the Terra Luna Cryptocurrency Crash: The End of the Crypto Market?

So-called stablecoins are sending shockwaves through the cryptocurrency markets: Currencies lose billions in value and liquid cryptocurrencies like Bitcoin are also crashing – which means for many investors that their savings are at stake.

In the past few months, Bitcoin has lost around 40 percent in value. And the two most important stablecoins of the crypto project Terra are also in free fall. Some are calling the crash a Ponzi scheme, similar to the collapse of Lehman Brothers that triggered the 2008 financial crisis.

Stablecoins are actually considered a relatively safe haven in the highly volatile crypto market. They are said to be tied to fiat money – a medium of exchange with no intrinsic value – and are typically pegged 1:1 to the US dollar. However, recent events have shown that they are just as volatile as other cryptocurrencies.

Stablecoin TerraUSD, or UST, had almost completely crashed on Thursday, losing its $1 peg to the dollar and falling to a low of $0.26.

Terra was among the top 10 most valuable cryptocurrencies and had peaked at almost $120 just last month.

Meanwhile, TerraUSD's sister token, Luna, is down more than 97 percent, below $0.22. On Friday, Luna almost completely collapsed to $0.

How did this crash happen?

Developed by Terraform Labs, UST is an algorithmic stablecoin. This means that the token is not backed with cash and other assets, but with a complex mix of code and Luna to stabilize the process.

"The idea of an algorithmic stablecoin is that instead of having a collateral pool, you have some sort of messy, low-quality bank reserve. So it seems like you've built a stable thing out of unstable things," said David Gerard, author of the book Attack of the 50 Foot Blockchain.

"Luna was a so-called governance token that made invented Ponzi money act like non-invented Ponzi money," he told Euronews.

Things got even more complicated after Terra's creator, Do Kwon, bought $3.5 billion worth of bitcoin to support UST in the event of a crisis.

Kwon's Luna Foundation Guard then tweeted that she had withdrawn 37,000 bitcoins — more than $1 billion at current rates — to lend them out.

The company said "very little" of the borrowed bitcoins have been spent, but it is "currently being used to purchase" UST. Many fear the Luna Foundation Guard will sell a large chunk of their bitcoins to support UST.

"I think the interesting aspect of this story is that there was a little financial crisis like in 2008," said Gerard.

"In the 2000s, people had so much money they couldn't invest it fast enough. They said, 'What's safer than real estate? Real estate doesn't go under. So they went on mortgages and mortgage-based loans. And that's how it came about Equivalents backed by a house price derivative," he added.

House prices fell, of course, and then all these safe dollar equivalents went down with them, and everyone who depended on them went down with them.

It was similar with Terra, says Gerard.

"It was based on nonsense and ultimately based on Bitcoin. In fact, Terra crashed the price of Bitcoin, which in turn crashed all other cryptos because they're all related," he said.

"So they started a little 2008. They switched leverage, got over-leveraged, collapsed and took the real asset with them."

Is more regulation needed?

The Terra saga has not only rattled the price of bitcoin and ether, but also the world's largest stablecoin, Tether, which fell as low as $0.98 on Thursday and is also said to be pegged to $1.

There are concerns as to whether Tether has enough assets to support its proposed $1 peg. The company had stated that all of its tokens were backed by a dollar reserve.

However, following a settlement with the New York Attorney General last year, it was revealed that Tether has backed its tokens with a range of assets, including commercial paper, a form of unsecured debt.

Given the many doubts surrounding stablecoin hedging, it is likely that there will be regulation soon.

U.S. Treasury Secretary Janet Yellen pointed to the TerraUSD as evidence of the potential threat to financial stability posed by unregulated cryptocurrency markets during a Senate Banking Committee hearing on Tuesday.

“A stablecoin called TerraUSD ran and then lost value,” Yellen said.

"I think that just goes to show that this is a fast growing product and there are risks to financial stability and we need a proper framework."

"I lost all my life savings"

But for many who have lost their savings in this recent history, regulation comes too late. Many users on Reddit shared their stories.

"I lost all my life savings," wrote a member of sub-reddit r/TerraLuna.

"I lost over $450,000, I can't pay the bank," wrote another forum user. The moderators of the Reddit page put a national helpline forum at the top of the thread.

"The key thing about the US story, aside from the fact that they triggered a small 2008 but actually it wasn't a small crowd, is that everyone knew that was nonsense," Gerard said.

“It was obviously nonsense. But crypto is full of gullible people who are sure there is a lot of money in Ponzinomics and they will get rich even if all the other fools lose their money.”

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