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Terra's Spectacular Collapse - Timeline Of Sharp Rises And Falls Of UST And LUNA

Terra's spectacular collapse, which subsequently devalued the algorithmic stablecoin and plummeted to a record low of $ 0.30, is the future of all stablecoins, not just algorithmic stablecoins.

The collapse of the algorithm Stablecoin UST has caused spillover not only in the crypto market but also among regulatory agencies around the world.

The success and stability of UST are intertwined with its brother LUNA, creating arbitrage opportunities that would theoretically stabilize UST prices.

If the price of UST falls below $ 1, it can be burned in exchange for LUNA. This will reduce the supply of UST and raise the price.

Conversely, if the price of UST rises above $ 1, LUNA may be burned in exchange for UST, increasing the supply of UST and lowering its price.

As long as the condition is normal and everything is working properly, this creates both a mechanism and an incentive to keep the UST price at $ 1.

Stablecoin in the algorithm is usually not backed by assets like other stablecoins, but the Luna Foundation Guard (LFG), the organization responsible for developing the UST and the broader Terra ecosystem, has stated. We are building a Bitcoin (BTC) war chest. Used when the UST is separated from the US dollar.

The idea is that if the price of UST drops significantly, you can lend BTC to traders to buy UST and push the price back to dollars.

Therefore, as the UST deepened, LFG bet more than $ 1.3 billion of BTC (42,000 coins at a price of $ 31,000 each) on traders looking to buy UST, creating demand pressure and supporting that bitcoin price.

However, it still couldn't save the collapsing ecosystem, and the spiral effect eventually caused the prices of LUNA tokens and their stablecoins to plummet.

After the collapse, even centralized stablecoins like Tether's USDT lost their dollar pegs and fell to a low of $ 0.95. As Stablecoin acts as a bridge between various decentralized financial ecosystems, the Terra crash has increased the volatility of decentralized financial markets.

Justin Rice, Vice President of Ecosystems at the Stellar Development Foundation, was very skeptical about the future of algorithmic stablecoin in light of the collapse of UST. He told:

“What we’re seeing now, and not for the first time, is an optimistic balancing mechanism unraveling due to natural human responses to market conditions. It is challenging to have algorithmic stablecoins keep their peg when things go sideways, and you have to rely on outside intervention to set things right.”

What Is An Algorithmic Stablecoin?

Stablecoin is intended to be a hedge against the volatility of cryptocurrencies and is easy to move between decentralized exchanges.

They are designed to maintain a certain value and provide one-to-one swaps between assets that are generally fixed in the US dollar.

Available products include Tether (USDT) with a market capitalization of over $ 83 billion and Circle (USDC) with a market capitalization of $ 43 billion.

TerraUSD is interdependent on another coin, Luna.

Each time a UST is created or created, Luna is burned and withdraws from the cycle. The same thing happens when Luna is cast.

This creates a trading margin and supply and demand model that helps lock the coin to $ 1.

Digital art of two bitcoin faced-man standing and one bitcoin faced-man sitting on a sofa
Digital art of two bitcoin faced-man standing and one bitcoin faced-man sitting on a sofa

Will UST Recover?

If the price drops below $ 1, traders can burn UST for $ 1 worth of Luna. This reduces aggregate supply and leads to higher prices.

When the value of UST exceeds $ 1, traders can burn Luna for UST to increase supply and lower prices.

In April, Terra temporarily became the third-largest stablecoin with a market capitalization of approximately $ 18 billion.

This is a stablecoin with a decentralized algorithm.

That is, it is not under the control that these actors may exercise because it is not supported by centralized entities such as banks and businesses.

Many such currencies have entered the market, but few have been successful so far. Traditional stablecoins are usually backed by reserves to maintain this one-to-one relationship.

But the algorithm Stablecoin works with more sophisticated math. They are based on algorithms and smart contracts that encourage traders to maintain a constant price.

Stablecoin Regulations Around The Globe - Terra Crypto Chart

Green-colored increase in open interest/volume ratio Terra Crypto Chart
Green-colored increase in open interest/volume ratio Terra Crypto Chart

Stablecoin has long been the focus of regulators in many major economies, but the collapse of the UST has acted as a catalyst for these volatile digital authorities in the United States, South Korea, and many European regulators.

Blockchain developer platform Lisk believes that the collapse of the UST is being used by lawmakers to promote the Central Bank Digital Currency (CBDC).

These can be imposed on lightly secured stablecoins such as USD Coin (USDC) and USDT.

Yellen said that aiming for a "single federal framework" for Stablecoin by the end of 2022 is "very appropriate" given the growth of the market. She called for bipartisanism among members of the House of Representatives to legislate such a framework.

Max Kordek, co-founder of the US regulators is using the case as a reason to enforce stricter rules for Stablecoin and its issuers, and Treasury Secretary Janet Yellen has announced a legislative plan by the end of the year.

“Trust in algorithmic stablecoins is likely to have greatly diminished because of this incident, and it will be a while before that trust is restored. This will, unfortunately, be used by politicians as an example of why the world requires CBDCs. We don’t need CBDCs; what we do urgently need, though, is reliable, decentralized stablecoins.”

The Congressional Research Service, a legislative body that supports the US Congress, has released a report on Stablecoin, an algorithm that analyzes UST crashes.

Research reports describe the LUNA crash as an "execution-like" scenario in which multiple investors simultaneously withdraw funds from the ecosystem.

Terra Crypto green and red-colored downfall graph
Terra Crypto green and red-colored downfall graph

The research paper regarding terra's spectacular crash states that in the traditional financial sector, these conditions are protected by regulations that prevent such scenarios, but without regulations, this could lead to market instability in the crypto ecosystem.

Jonathan Azeroual, Vice President of Blockchain Asset Strategy INX, told:

“Algorithmic stablecoins backed by super volatile assets are especially at risk of a ‘run’ on the funds backing them if investors lose confidence in the mechanism created to ensure its stable value or simply if the value of the assets backing them falls below the amount of stablecoin issued to.”

People Also Ask

Are Terra And Luna The Same?

The company tweeted that the old blockchain is called Terra Classic (LUNC) and the new blockchain is called Terra (LUNA). Luna tokens are new and should not be confused with old tokens of the same name.

Can Terra Luna Reach $1000?

No, Terra (LUNA) is not expected to reach $ 1000 by the end of 2025. This is only plausible if the demand for stablecoin on the Terra network is growing very rapidly. As a result, most of the LUNA supply will be burned to prevent Stablecoin from deviating from the terra crypto price forecast.

Conclusion

It is important to note that Terra's spectacular collapse due to general market modifications led to a cascade of secondary effects. At least a temporary slowdown of Defi (total value locked, activity down) and liquid betting issues.

The regulatory debate surrounding Stablecoin gained momentum in the face of the UST blunder, but it also shows that the crypto market has developed enough to absorb the $ 40 billion drop. This proved that the crypto market has grown enough to absorb as much of a setback as Terra without compromising overall market stability.

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