Terra Luna: The collapse of one of the largest crypto on the market

The crypto Terra Luna, which also had one of the largest stablecoins on the market, as we know, drastically collapsed in May 2022. 

The blockchain-related project Terra, which was born in 2020, suddenly crumbled into dust, while the two cryptocurrencies, Terra USD and Luna, which were its mainstay, collapsed irretrievably, sending an untold number of investors to the brink. 

When looking at the numbers, it is clear the magnitude of the disaster that overwhelmed a project whose market capitalization, in its heyday, had reached nearly $60 billion. Not only that, Terra was among the most highly rated projects in the industry and was considered a spearhead in blockchain-based DeFi.

What Crypto Terra Luna was and how it worked 

At the time of the collapse of TerraUSD and Luna, the values of what were two promising cryptos in the market dropped dramatically. 

In fact, the value of TerraUSD, which was supposed to be fixed and always equal to one dollar, was worth about sixteen cents; while, the value of Luna, went from the high of $120 down to a fraction of one cent. In summary: of the $60 billion total maximum value, there was nothing left.

Before understanding why Terra Luna collapsed, it is important to explain, albeit briefly, what the mechanism behind the Terra Luna project was and how it worked. 

Terra was an “algorithmic stablecoin,” which used a complex system to ensure that the value did not fluctuate. In extreme summary, Terra relied on an algorithm that controlled its price by manipulating the issuance of coins. 

This meant that when the price went up, the algorithm generated new coins to make it go down; when it went down, it destroyed the ones necessary to make it go back up. All these maneuvers were programmed into the smart contracts, the automated contracts that execute when the conditions signed by the parties are met, of the Terra blockchain.

TerraUSD’s balanced condition is also maintained through the joint action of a second cryptocurrency: Luna. Indeed, investors were able to exchange 1 TerraUSD for one dollar of Luna’s value. 

The moment this exchange took place, a new Luna was created while a TerraUSD was destroyed, and vice versa. All of this was necessary to take advantage of what is known as arbitrage: at certain times it was possible for TerraUSD to fall slightly below a dollar of value, and so it was worth exchanging it for a dollar of Luna value to make a profit. 

Incentivizing investors to this exchange would destroy the traded TerraUSD, making it scarcer and thus helping the price return to expected values. If the price rose too much, it was worthwhile instead to exchange a Luna dollar for a TerraUSD that, at that moment, was worth a little more than a dollar, making a profit and allowing the stablecoin to return to its equilibrium point.

In addition, the Terra project had its main application in the world of DeFi and was employed specifically on the lending protocol known as Anchor. This protocol allowed people who deposited their TerraUSD in them to earn 20% interest annually. At one point, 14 billion of the total 18 billion TerraUSD in circulation were held on this protocol.

Why Terra Luna collapsed 

Suddenly, however, things went all wrong producing what was the drastic market crash witnessed by many thousands of investors. 

Indeed, in May 2022, TerraUSD’s deposits on Anchor suddenly began to be withdrawn, dropping from 14 billion down to 3 billion, and then falling even further. 

Terra’s founder, Do Kwon, thinks it was a conspiracy, given the suspicious speed with which all the funds began to be withdrawn. Thus, even the algorithm of a stablecoin designed to keep the price fixed failed to react in time: on 10 May, the value of TerraUSD fell to 70 cents. 

Terra’s founders immediately tried to locate the economic resources needed to keep it afloat, but to no avail: the next day, it dropped again to 33 cents and then went as low as 16 cents.

Because of the relationship between the two cryptocurrencies, the market was flooded with Luna, whose value began to plummet starting an unstoppable chain reaction. This reaction wiped out any value of the coin, whose capitalization fell from an all-time high of 40 billion to 200 million. On the morning of 13 May, the value of one Luna, the crypto that had surpassed $120, was $0.00004046.

The case of Near Protocol

In the wake of Terra Luna’s disaster and mistakes, other major crypto and blockchain systems are also afraid and want to avoid a drastic demise. 

This is the case of Near Protocol, the decentralized application platform, which, in order to reduce its Terra-like stablecoin, has decided to phase out its USN through its collateral. 

As a competitor to Ethereum, NEAR is a popular blockchain for the creation of decentralized apps (dApps) and the minting of NFTs. Since April it has had its own stablecoin, USN, issued by DAO Decentral Bank.

Near Protocol’s blockchain is designed to make apps usable on the Web. Its network runs on a Proof-of-Stake (PoS) consensus mechanism called Nightshade, which aims to offer scalability and stable rates.

However, the decision to shut down NEAR Protocol’s stablecoin comes because the blockchain has begun to exhibit risky characteristics similar to those observed with TerraUSD. 

USN was recently under warranty, according to a Monday statement from the NEAR Foundation, a nonprofit organization that supports the blockchain. This means there is not enough collateral backing the token.

Consequently, the NEAR Foundation added, the token would be shut down. In fact, Decentral Bank announced later that it would indeed shut down the USN project.

“The USN has faced many adversaries in recent months with increased attention to regulation and changes in market perception due to recent high-profile incidents. Due to these issues, we have made the difficult decision to close the USN project in a controlled and responsible manner in order to ensure the protection of USN holders,” 

the Decentral Bank statement said.