what happened? Terra debacle exposes flaws plaguing the crypto industry

The past week has been a dark period in the history of cryptocurrencies, with the industry’s total market capitalization falling to $1.2 trillion for the first time since July 2021.Unrest is largely due to Terra’s real-time disintegrationa Cosmos-based protocol that powers a suite of algorithmic stablecoins.

About a week ago, Terra (Luna) among the 10 most valuable cryptocurrencies on the market with a single coin trading The price is $85. However, by May 11, the price of the asset had fallen to $15. And, after 48 hours, the coin has lost 99.98% of its value and is currently trading at $0.00003465.

Terra’s other related product, TerraUSD (UST) — an algorithmic stablecoin pegged 1:1 to the U.S. dollar — has lost its peg to the U.S. dollar due to the ongoing crash, and is currently trading is $0.079527.

Terra Ecosystem Explained

As mentioned above, the Terra protocol is powered by the use of two core tokens, UST and LUNA.Network participants are capable of Cast UST by burning LUNA Portal at Terra Station. In short, the Terra economy can be envisioned as consisting primarily of two pools: one for TerraUSD and one for LUNA.

To maintain the value of UST, the LUNA supply pool either increases or decreases its coffers, so clients need to burn LUNA to mint UST and vice versa. All of these actions are incentivized by the platform’s algorithmic market module, making UST’s functional framework quite different from that of its closest stablecoin competitor, Tether (UDST) and dollar coins (USD/USD), both are directly backed by fiat assets.

To better illustrate how USTs (or algorithmic stablecoins in general) work, it’s best to use a simple explanation. For example, let’s say UST is worth $1.01, then users are incentivized to use Terra’s exchange module to exchange $1.00 worth of LUNA for 1 UST, allowing them to earn a net profit of $0.01.

Now, when the tide turns and UST falls to $0.99, network users can do the exact opposite, resulting in the protocol not allowing some users to be able to exchange $1.00 worth of UST for $1.00 worth of LUNA. This once-hypothetical scenario is now a reality, leading not only to the unraveling of the Terra protocol, but also to the reputation of the crypto industry in the eyes of global investors.

Damage control but to no avail

When LUNA and UST were in free fall earlier this week, the protocol’s co-founder Do Kwon release A series of tweets announced remedial measures to control further bleeding. As an initial response to the decoupling of the UST from the dollar, Kwon strengthen The burning of the UST, what we now know in hindsight, didn’t work.

Kwon claimed that by increasing the base pool from 50 million to 100 million special drawing rights (SDR) and reducing the PoolRecoveryBlock from 36 to 18, the minting power of the protocol could potentially increase from $293 million to as much as $1.2 trillion.

In short, by deploying the above changes, the Terra team was able to Mint UST out of nothing has quadrupled Dubbed Kwontative easingJack Tao, CEO of cryptocurrency exchange Phemex, who provided an expert opinion on the matter, told Cointelegraph that looking back now, the signals of disaster around UST and LUNA have been around for a long time.

First, he argues that the general idea around algorithmic stablecoins is inherently fragile, as these products lack any type of actual backing asset.Second, the Luna Foundation has been making a lot of noise lately, when Do Kwon announced that he would be the Purchases totaling $10 billion in Bitcoin (bitcoin) as a reserve for the UST. To this, Tao added:

“These purchases resulted in an oversupply of UST, and once the selling pressure on LUNA and UST started to rise, it began to fall rapidly. Once this sell-off occurred, Luna Foundation Guard had to sell its bitcoin to maintain the peg. However, reflex selling pressure continued , all underlying assets began to fall sharply.”

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Tao went on to add that Anchor Protocol — a savings, lending platform built on the Terra blockchain — which promises an unrealistic 20% annual yield (APY) on UST staking, also played a role in the development process. Important. When UST’s selling pressure rises, it loses its $1.00 peg and begins to fall uncontrollably:

“Once Binance liquidity dried up, Curve’s two UST pools started selling UST and Anchor’s borrowing levels dropped by over $1 billion. So the wider ecosystem is now plagued by confidence issues, especially when it comes to stablecoins .”

Terra officially goes offline after debacle, albeit briefly

On May 12, the validator collective serves the Terra network Decide Cease any digital activity related to the ecosystem to mitigate potential governance attacks, especially when the network’s LUNA token recently fell below 1 cent.

So far, Terraform Labs’ official Twitter account has revealed that all network activity has stalled at block height 7,603,700. With LUNA’s value down nearly 100 percent, a spokesperson for the company said developers were no longer confident in their ability to prevent third-party governance hacks. The downtime, however, was brief, and Terra’s core team revealed that it will restart operations as soon as validators are able to apply a patch that disables all further delegation.

As the LUNA/USDT trading pair fell below the 0.005 USDT mark, Delisting from Binance. The previous day, cryptocurrency exchange Huobi removed the LUNA token. Before the aforementioned events, UST was the third largest stablecoin by total market capitalization, after Tether and USD Coin.

Poor outlook for the industry as a whole

In Tao’s view, the whole incident will have a negative impact on the crypto industry’s image, especially in the eyes of investors. In particular, he believes that the crash could lead to lawmakers becoming more strict about decentralized stablecoins and may even lead many governments to actively explore creating their own centralized stablecoins and central bank digital currencies (CBDCs), adding:

“Unfortunately, the LUNA situation will leave a bad impression on everyone as it has caused many great altcoins to lose enormous value. However, a bigger and more important aspect of this development is its timing “This is all happening at a time when wars are raging in Eastern Europe, global supply chains are constrained, inflation and interest rates are rising.”

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That being said, he does admit that there could be a silver lining in all of this: The event could lead to the survival of only the best projects, with most sketchy platforms largely losing investor interest. “From now on, there will be more scrutiny and investors will feel the option to only invest in the biggest cryptocurrencies like Bitcoin, Ethereum and Solana,” he said.

So it will be interesting to see how this story continues to unfold and what effect this event has on the development/evolution of the cryptocurrency market as a whole, especially as the traditional financial system also continues to be ravaged by more and more cryptocurrencies in the event of adverse financial stress.