In recent times, the crypto space has been beset by a myriad of challenges, particularly the decline in the value of cryptocurrencies. The market has been unstable since the third quarter of 2021, after an impressive bull run, with many cryptocurrencies losing value. Since then, many cryptocurrencies have failed to reach all-time highs.
Aside from the aforementioned, events in the Terra ecosystem have left some crypto enthusiasts with a bad taste in their mouths.
All the cryptocurrencies, including the stablecoins that are part of the Terra ecosystem, have recently experienced a sharp decline, with some of them losing 99% of their value.
This article analyzes the how, why, and events that led to the steep decline in the value of LUNA and TerraUSD.
What is Terra?
Terra is a blockchain platform that allows developers to create various stablecoins that are denominated in different currencies. It is the home of algorithmic stablecoins, which are digital assets that track the value of both currencies and other assets.
Terra is known for being open-source, allowing developers to create a variety of stablecoins. The Terra ecosystem is made up of two major types of cryptocurrencies: LUNA (the native token) and TerraUSD (the stablecoin).
The price of Terra stablecoin is kept stable by balancing demand and supply via LUNA, according to the ecosystem’s concept. LUNA is usually used as a benchmark for these stablecoins.
LUNA was once the sixth most valuable cryptocurrency by market capitalization. In recent times, the coin’s value has plummeted from an all-time high of $120 to below $1 in a matter of weeks.
Terra was created by Terraform Labs, a South Korean blockchain startup. Do Kwon and Daniel Shin launched the blockchain platform in 2018, and it has since grown to become one of the most powerful forces in the blockchain space.
Both founders have a technological background and have worked for large tech organizations.
What Happened to Terra?
The decline in the value of TerraUSD had an impact on the value of LUNA, causing it to crash as well. The Terra protocol designed the TerraUSD architecture to be linked to the Anchor Protocol.
Anchor Protocol began by offering crypto enthusiasts a 20% interest rate if they deposited their TerraUSD with them. This was one of the factors that drove up demand for UST.
During that period, more people began to hold UST to benefit from the high-interest rate, which was higher than the regular rates available in the crypto market.
Anchor Protocol decided to make significant modifications to the rate it offered its users in March 2022, converting the 20% standard rate to a variable rate. With the new variable rate, it was obvious that the new return on investment (ROI) would fall below 20%. This rate modification irritated numerous holders, forcing them to leave Anchor and sell their UST and LUNA.
The crypto market was flooded with users attempting to sell their tokens at the same time. Because the cryptocurrency market follows the laissez-faire system, the invisible hands of demand and supply are at work. According to basic economic theory, a high level of supply reduces the value of a commodity.
This was what played out in the case of UST and LUNA. As more people started to withdraw their UST from Anchor Protocol, the value of the stablecoin reduced, which prompted others to do the same.
As a result of this, LUNA Foundation Guard, a nonprofit organization that is linked to Terra and founded by Do Kwon decided to maintain the UST peg by touching its bitcoin reserves. To achieve this, they had to sell their stockpile of Bitcoin, which made the value of the foremost cryptocurrency drop.
With the sudden price drop of UST, more LUNA was being minted to try and stabilize the value of TerraUSD. This also led to an increase in the number of LUNA tokens that were available in the market.
UST is designed to be an algorithmic stablecoin, meaning that its value is tied to the volatility of the market. Some believe that the already red crypto market may have affected both cryptocurrencies negatively.
The Aftermath: Court Cases
Due to the decline in the value of LUNA and UST, Terraform Labs and Do Kwon are both facing legal action from individuals. At the time of writing, the South Korean government had not filed any charges or taken any action against Do Kwon.
According to local media, South Korean authorities instead established an emergency study to evaluate the implications of cryptocurrencies on the economy, particularly in light of Terra’s incident. The South Korean financial authorities, the Financial Services Commission (FSC) and Financial Supervisory Service (FSS), will study the implications of cryptocurrencies as part of the emergency assessment program, which will result in the “Digital Asset Basic Act,” a new law to guide crypto activities.
After the values of UST and LUNA plummeted, some private investors hired the legal firm, LKB & Partners, to sue Do Kwon. The law firm LKB & Partners is well-known in South Korea, and as of the time of writing, it intends to file a case against Terra’s founder with the Seoul Metropolitan Police Agency.
Based on local reports, some employees in the law firm were also affected by the drop in value of the cryptocurrencies linked to Terra and wanted to seek redress in court.
Kim Hyeon-Kwon, a partner at LKB, stated that,
“There are related investors inside the law firm, and we will file a complaint against Kwon at the Financial Investigation Unit of the Seoul Metropolitan Police Agency.”
Aside from the aforementioned, the renowned law firm has also filed a provisional attachment order with the authorities, requesting that properties linked to Kwon be seized and used to compensate some of Terra’s victims.
Terraform Labs appears to have lost its internal legal team as a result of the recent crisis, as some members of that team have left the company. “
The LinkedIn profiles of Terraform Labs’ general counsel, Marc Goldich; chief corporate counsel, Lawrence Florio; and chief litigation and regulatory counsel, Noah Axler, show that all three stopped working for the company in May — all after less than a year at the company. “
These individuals are among those who left when the value of UST and LUNA dropped. Terraforms Labs has reportedly employed the services of an external legal team.
How Did Binance Lose?
The steep price drop of Terra’s cryptocurrencies affected several individual investors and crypto firms.
When Terra was created in 2018, Binance invested $3 million into LUNA and was given 15 million tokens. By April 2022, the value of those coins had increased to $1.6 billion. According to a tweet by Binance’s Chief Executive, C. Zhao, “Binance received 15,000,000 LUNA (at peak worth $1.6 billion, now not much) as part of the original ($3 million) investment — a 560x return at peak.” With the recent drop in the value of LUNA, the price of the tokens has fallen to roughly $2,391.
Though Binance may have lost funds as a result of the disaster, Zhao has emphasized that he wants the average crypto user to be prioritized in terms of Terraform Labs refunding them. He stated in his tweet,
“To lead by example on PROTECTING USERS, Binance will let this go and ask the Terra project team to compensate the retail users first, Binance last, if ever.”
- UST has dropped in value from its regular $1 peg.
- The drop in value of UST affected its sister cryptocurrency, LUNA.
- The reason for the drop in both cryptocurrencies is linked to the Anchor Protocol changing its rate of return.
- The South Korean government has begun to assess the economic consequences of the debacle.
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