If you were told a month ago that a top 10 coin by volume, that millions of people invested in, would lose all of its value in just one week, you wouldn't believe it. This is a top 10 coin we're talking about, not some random token!
Well, it had happened, and it was also coupled with the biggest nightmare of every trader, a stable coin losing almost all of its value.
This was the fate of the Terra blockchain and its currency: LUNA and UST. This crisis shocked the whole cryptocurrency market and caused a big plunge in almost every mainstream coin like Bitcoin, Ethereum, and Binance coin.
Who is Terra?
Terra is a blockchain platform created by Terraform Labs in South Korea. The Terra blockchain uses a proof-of-stake process and has a much faster transaction speed than Bitcoin. Earlier this year, Terra's currency, LUNA, was the largest decentralized finance token by market capitalization.
LUNA and UST
Terra blockchain has two popular currencies, one is LUNA and the other is UST. UST (Terra USD) as the name suggests, is a stable coin that is pegged to the US dollar. Unlike Bitcoin which has a fixed supply, the supply of UST is determined by the demand for it, which, in theory, enforces the 1:1 relationship the coin has to the US dollar. Hence, the UST is known as an "algorithmic stable coin" and not like any other stable coin that has real fiat or collateral behind it.
The relationship between UST and LUNA involves minting and burning coins to keep UST value at $1 per coin. If the value of UST falls, LUNA will be minted (increase supply) to stabilize the price of UST.
The system was also designed to keep UST value through market arbitrage. If the market value of UST slipped to $0.99 or less, enough buyers should theoretically enter the market to raise the value, and if the value went to $1.01 or higher, enough holders would sell to lower its value.
The Crash of UST and LUNA
On May 7th, hundreds of millions of UST were suddenly sold and this caused a massive reaction to UST, making the price fall from $1 to $0.91. The massive sell-off is thought to be an attack on the Terra blockchain to take advantage of the price drop.
The algorithm designed wasn't enough to immediately recover the price of UST back to $1 and this caused investors worldwide to lose confidence in UST and continue selling it, lowering the price even more.
According to the algorithm of UST, LUNA is supposed to be minted to burn UST and keep the price stable. However, the massive sell-off was too much for the algorithm to handle, and LUNA supply rose 1,900,000%, resulting in LUNA losing most of its value per coin.
Many exchanges took down trading and withdrawal of UST and LUNA to stop the sell-off, making many traders lose access to their assets.
What can we learn from UST and LUNA collapse?
One of the most important lessons every trader can learn from this is to always diversify their portfolio. Due to UST's and LUNA's low-risk profit and high APYs staking options, many investors poured their wealth into these coins, not knowing that this crisis has washed all of their wealth away.
It is also a wake-up call to investors who invested in other DEFI projects. If this was an attack on Terra, it can be concluded that any organization with large capital can pull off another similar attack on another DEFI blockchain. Hence, diversification is incredibly important.
Another lesson we can learn is that exchanges can remove trading pairs and ban withdrawals at any time, like what many exchanges have done so against LUNA and UST without any notification.
This highlights the importance of cold wallets even more than before. When coins are kept in the wallet, the wallet owner will ALWAYS have access to the coins, no matter what the crisis.
A cold wallet like the ELLIPAL Titan Cold Wallet is also very suitable for portfolio diversification. With multi-currency per account set-up, wallet owners can easily store every supported currency under one account and look over them all at once, without needing to keep switching accounts like other wallets. It is a perfect cold wallet to start using after learning about the risks from the Terra crisis.
