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Understanding the collapse of Earth (LUNA), TerraUSD (UST) and its entire ecosystem

While Bitcoin’s volatility may attract investors, it also stuns many others. No wonder, stablecoins are already giants in both market capitalization and trading volume. However, many are still looking for the perfect coin.

To understand this case, one has to go back in time, before the birth of Bitcoin. In 1996, Douglas Jackson created E-Gold, a gold-backed digital currency that was stable and countered the inflation of fiat currencies. However, its creator was a central point of failure, which ended the project after his arrest for facilitating illicit transactions.

Bitcoin solved this issue, making it impossible to turn it off. However, as stated above, its volatility does not please everyone. Thus, stablecoins began to emerge, whose objective is to maintain parity (1:1) with the dollar, or other currencies.

1:1 backed stablecoins

First came the “dollar” backed currencies, such as Tether (USDT), USD Coin (USDC) and others. Although they do not have dollars in the bank to back them up, companies in these currencies have reserves in liquid assets such as government bonds, commercial papers and, surprisingly, even cryptocurrencies. This is one of the first risks on them.

However, the risks remain, after all the same factors that brought down E-Gold exist here. The government can easily freeze the funds of these companies, which almost happened in the Tether lawsuit last year.

In addition, such companies can, and are, required by the courts to freeze addresses of certain users. So it doesn’t seem stable at all if your money can go from $1 to zero, as Edward Snowden pointed out.

Decentralized stablecoins with excess collateral

With this, decentralized stablecoins were born that have excess assets for them to be backed. The most famous of these is DAI (DAI) which uses other cryptocurrencies such as Ethereum and Bitcoin in its backing. For their “support”, such investors receive an annual return on the fees charged by the protocol.

However, for it to work, investors need to deposit a higher equivalent amount. For example, depositing the equivalent of $1,500 into Ethereum so that $1,000 worth of DAI is created. If the ETH price drops, they can add more ETH to keep the excess, or they will have these funds automatically liquidated.

Algorithmic stablecoins

Therefore, some people believe that these excess guarantees are unnecessary. Then dozens of algorithmic stablecoins appeared on the market, and while most quickly failed, UST grew to $18.8 billion, making it one of the biggest cryptocurrencies on the market.

In addition to including a game theory, where everyone wins if everyone helps each other, theoretically other incentive mechanisms keep its price. That is, if its price is higher than $1, people can mint more coins for $1 and then sell them. If it’s smaller, they can buy them on the open market and then exchange them on the protocol for $1.

This would make the UST not lose its parity. However, by not having excess guarantees (not even 1:1), it made the UST become dependent only on game theory. Thus, the mass sales destabilized its price to the point that the mechanisms became useless, causing even more consequences.

One of them was the fall of 87% of the Earth (LUNA), currency to be minted by the exchange of UST, due to inflation. Then another aggravating factor is added to this, after all, now it would be necessary to print even more LUNA to maintain the UST, which would continue to bring its price down.

In addition, another curious point is that, in March, Terra had bought 1.5 billion dollars (R$ 7.65 billion) in Bitcoin (BTC) to help with these incentives. However, it had to sell them accordingly this week, causing stress even for BTC, already in decline.

UST crash may have been an attack

For conspiracy theorists, the fall of the UST may have been a planned attack. According to these rumors, an attacker could have bought billions in UST and then dumped such coins on the market while opening shorts in Bitcoin (BTC), TerraUSD itself (UST) and also Terra (LUNA).

After all, after the panic started to see the UST losing parity, the company would be forced to sell its bitcoins, bringing its price down. On the other hand, the UST, dependent on trust, would no longer have this trust, and LUNA, for the reasons mentioned above, would also be weakened.

While other algorithmic stablecoins have similarly died, it is worth noting that none of them were the size of TerraUSD (UST). So if it was an attack, it took a lot of money.

In addition to the vulnerability of these stablecoins, many do not like Do Know, creator of Earth. As an example, in March an investor accused Terra (LUNA) of a financial pyramid and bet R$5 million, with Know himself, that its price would be lower in 12 months.

Earth Team remains hopeful

On his social networks, Do Know himself continues to believe that he can save the UST from collapse, despite the 77% drop this Wednesday morning (11). Its first step is to approve a proposal that accelerates the “absorption” of UST. Furthermore, he seems to have noticed that the UST model was not sustainable.

“As we begin to rebuild the UST, we will adjust its mechanism for assurance.”

In addition to him, other team members continue to try to get the water out of the leaky boat, trying to save both the UST and their egos. The bravest ones are already buying LUNA, believing that it can also be saved.

“In total, I bought about 100,000 LUNA. Stick it in your wallet and see what happens in a few years. It could be the best/worst trade of my life. I saw an opportunity and had to seize it.”

At the moment, such an investor appears to have made the worst investment of his life. After all, your purchase of LUNA was made at US$ 15 and the currency is already around US$ 2, a loss of 86% in less than 24 hours.

Every ecosystem on Earth affected

Finally, in addition to the fall of TerraUSD itself (UST) when Earth (LUNA), it is worth remembering that there is an entire ecosystem around these coins. CoinMarketCap shows 17 “Luna ecosystem” tokens with price registration.

Tokens in the Earth ecosystem. Source: CoinMarketCap

Obviously, all are showing strong lows, after all they are linked to the two Do Know currencies. Furthermore, although one of the main characteristics of an algorithmic stablecoin was its decentralization, such a fiasco proved that UST is far from independent and that in addition to being “more of the same”, it also has more weaknesses.

As for the future of stablecoins, it looks bleak. After all, this case has already become a subject in the US Congress, tending to accelerate the regulation of such currencies. So, this should be yet another event of great impact to all other cryptocurrencies, including Bitcoin, due to the large volume of these pairs.

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