The Wall Street Crash of 1929, The Asian Financial Crisis of 1997, the Great Recession of 2008, and now the Crypto Crash of 2022—this week will live in infamy for the rest of financial history. As thousands of investors from across the globe lose over $600 billion in the largest single crypto market crash in history.
In one week, one of the industry’s largest stablecoins, TerraUSD or UST, saw its value drop by over 50% and its sister cryptocurrency Luna fell by as much as 99% to nearly $0. This completely destabilized the crypto market and nearly every major coin and token saw its value nose dive into the red.
Impact Felt Beyond Stablecoins
Bitcoin alone saw its value this week drop by nearly a quarter, down to a low of $26,000, a drop not seen since the onslaught of the global pandemic in early 2020. Ethereum saw its value drop by another 30%, trading at a low of $1,900. Altcoins Cardano, Solana, and Avalanche also tumbled an additional 25% to 30%. With meme coins, Dogecoin and Shiba Inu also fall another 30% alongside the rest of the crypto market.
As with any major financial disaster, we must ask where the origin of the fire occurred and why it happened. Why did TerraUSD fail and does this signal a larger widespread problem with algorithmic pegs?
Who Is Terra/Luna?
In 2020, Forbes 30 Under 30 stars Do Kwon and Daniel Shin sought to create the next great stable coin. Outstripping the current market leaders GUSD (Gemini) and PAX (Paxos), Terra grew quickly and voraciously. Launching its blockchain through Terraform Labs, a sister token Luna, and its reserve the Luna Foundation Guard.
The Luna Foundation Guard was formed specifically to manage the teams at Terra and Luna—and as the ultimate life raft, should the stable coin ever lose its peg to the US dollar. The Foundation set a goal to reserve $10 billion in Bitcoin to back its stable coin UST. However, with no other real asset to peg against its stable coin, the confidence in TerraUSD soon found itself in a state of crisis.
What Went Wrong With Terra?
Early on May 9th, 2022, the once most sought after and trusted stable coin on the market, lost its $1 peg. And plunged initially from $1 to as low as $0.08 and is continuing to drop as of the time of writing.
After UST initially de-pegged from the dollar, the curve pool containing UST emptied, or investors began cashing out all of their UST for other stable coins. Then an extremely short sell-off of Luna, the sister token meant to power and serve as collateral for UST plummeted.
This, in combination with the creation of more minting of Luna to offset the downward spiral of UST, caused a further dilution of both assets. Neither faith in the Terra renewed nor was it in Luna—which ultimately proved too great for the protocol to support.
And so, on this day in May, the crypto market and larger investing community at large saw the death of a giant. One with ambitions too large to match their britches. And if it serves as a lesson, it is this: trust your intuition when something is too good to be true.
How to Move Forward
Moving forward, retail and institutional investors alike will have to look deeper into a project’s trustworthiness the next time they choose to hold their reserves with them. And no doubt that central banks and elected representatives will look to regulate the stable coin industry.
With thousands of investors pooling their savings into stable coins with the hopes of a haven for their earnings, governments will have to ensure that the next Terra or Luna isn’t a house of cards capable of falling with the slightest gust of financial wind or market storm.
There is hope, however, as other stable coins like USDC or USD Coin lead the way with regulation, regular auditing, and real reserves of their assets. You can trust that this crypto market crash will lead to a litany of innovations in the stable coin field. And hopefully, with talented engineering, creative spending, and a little luck, the crypto market will emerge from these sullen times.
The crypto dream that so many of us have dreamt of is right around the river bend. We simply have to make it through this bitter financial winter and into the bull season that awaits us just around the corner.
