Why Did Terra Luna Crash? Understand How UST And LUNA Lost All Value

LUNA is the native cryptocurrency of the Terra ecosystem. Before the Terra Luna crypto crash happened, the cryptocurrency was among the top 10 largest crypto coins in the world by its total market capitalisation and also one of the most popular. However, since the crash, Terra Luna has lost over 99.9% of its value. Why did a once popular and trusted crypto project crash and burn to an extent where almost all of its value was wiped out? Let’s try and understand.

Terra is a blockchain platform that caters to the creation of stablecoins. This blockchain network was created in 2018 by Do Kwon and Daniel Shin of Terraform Labs. The Terra blockchain platform also provides the capability of smart contracts and DApps. As mentioned above, LUNA is the native cryptocurrency token of the Terra platform and is used for carrying out transactions and paying gas fees. Moreover, LUNA holders can also partake in the platform’s governance system by voting on proposals related to changes in the Terra ecosystem. Finally, since the Terra blockchain functions on a proof-of-stake basis, LUNA is staked in the ecosystem for consensus and validation of network transactions.

UST is a stablecoin in the Terra ecosystem. Stablecoins are those cryptocurrencies whose value is pegged to another commodity, currency or financial instrument. However, UST is an algorithmic stablecoin, meaning its value is not backed by any real assets. The value of UST is backed by Luna instead and it uses a unique algorithm to always maintain the value of 1 UST = $1. If the price of UST goes up above $1, the algorithm mines more LUNA tokens in order to stabilise the value of UST at $1 and vice versa.

Before the LUNA crash, about $2 billion worth of UST was unstaked from the Anchor Protocol and hundreds of millions of it were then immediately sold. It is still unknown exactly why someone carried out this action but some suspect that it was a form of a malicious attack on the Terra ecosystem. This large sell-off pushed the price of UST down to $0.91 cents. So people started to purchase LUNA with UST in droves because even if the price of UST is lower than $1, 1 UST can always be redeemed against 1$ worth of LUNA.

However, at the same time, the overall crypto market was experiencing a major crash, which lead to the price of LUNA crashing. At this point, the market capitalisation of LUNA fell below UST. This was a problem because the UST was algorithmically linked to LUNA for stabilisation. As a result, the UST got de-pegged since the total value of UST could not be redeemed against LUNA. As the UST got de-pegged, everyone who held this stablecoin started selling it off since they lost confidence in the coin. This also directly caused the value of LUNA to crash at a very fast rate.

All of this happened in such a short duration of time that the algorithm which maintained the value of UST at $1 failed to maintain the stablecoin’s price. Since the prices of both UST and Luna started crashing hard at the same time, investors sold off all their holdings on the open market. The significantly increased supply of LUNA on crypto markets along with the de-pegging of UST ultimately made investors lose confidence in the project and so the price of LUNA continued to crash till it was basically worthless.

As a result, LUNA and UST were delisted from most major crypto exchanges around the world. While the co-founder Do Kwon came up with a plan to revive the cryptocurrency, crypto experts are skeptical about the chances of LUNA recovering to its original price.

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