History of Terra, the cryptocurrency that has been pulverized

History of Terra

Hard times for cryptocurrencies. Although on May 13 the market made a sharp rise, bitcoins are still in the red by 17% compared to a week ago and are now worth half of last summer's highs. In the past seven days, Ethereum has also dropped by 25%. More generally, the entire crypto-market (which today is worth $ 1.250 billion) has dropped by about 60% from last November's highs.

In the midst of this far from rosy situation ( and which concerns the financial market in general, starting with Nasdaq), however, there is a project linked to the blockchain - Earth, born in 2020 - which has suddenly become pulverized, while the two cryptocurrencies that served as its pillar have collapsed in a irremediable, sending an unspecified number of investors blinded by promises of quick profits to the streets.

Taking a look at the Reddit channel dedicated to the Earth project, there are several similar stories. “I lost my life savings, I'm not sure what to do,” writes one user. Others report the loss of figures ranging from 15 thousand to 450 thousand dollars: "I am not able to repay the bank and soon I will also lose my house", writes another.

If you look at the numbers, you understand the he extent of the disaster that engulfed a project whose market capitalization - in its heyday - had reached nearly $ 60 billion. Not only that: Terra was among the most popular projects in the sector and was considered a spearhead in the field of DeFi: decentralized finance (loans, betting and more) based on blockchain.

Why bitcoin has plummeted to lows since summer 2021 The most important cryptocurrency in the world has lost about half of its value, dragged by rising inflation and the crisis of the traditional markets Earth and Moon Of the two cryptocurrencies behind this project, the first, TerraUSD, whose value should be fixed and always equal to one dollar, is worth at the time of writing 16 cents; the second, Luna, went from the highs of $ 120 last April to the fraction of a cent today. In short, nothing is left of the 60 billion total maximum value.

What happened? Let's start with the first of the two currencies involved: TerraUSD is a stablecoin, a "stable" cryptocurrency designed to have a fixed value, usually pegged to the dollar or euro. Its purpose, among others, is to offer immediate shelter in the event of a market fluctuation. Some of the most important stablecoins - such as Tether or USD Coin - keep their value fixed thanks to economic reserves equivalent (at least in theory) to the value in circulation.

How does Terra Terra, however, is an "algorithmic stablecoin", which uses a complex system to ensure that the value does not fluctuate. In a nutshell, Terra relies on an algorithm that controls the price by manipulating the issue of coins. When the price goes up, the algorithm produces new coins to make it go down; when it goes down it destroys those necessary to make it go up again. All these maneuvers are programmed in the smart contracts - automatic contracts that come into execution when the conditions signed by the parties are met - of the Terra blockchain.

This equilibrium condition of TerraUSD is also maintained thanks to the joint action of a second cryptocurrency: Luna. In fact, investors can always exchange 1 TerraUSD for a dollar worth of Luna. As this trade occurs, a new Moon is created while a TerraUSD is destroyed, and vice versa. What is all this for? To take advantage of what is known as arbitrage: in some moments it is possible that TerraUSD falls slightly below the dollar in value, and therefore it is worth exchanging it for a dollar of Luna's value to make a profit. By incentivising investors to do this, it destroys the traded TerraUSD, making it scarcer and thus helping the price to return to expected values. If the price rises too much, it is instead worth exchanging a dollar of the Moon for an TerraUSD which at that moment is worth just over a dollar, earning and allowing the stablecoin to return to the equilibrium point.

The Earth project, however, had the its main application in the aforementioned world of DeFi and was used in particular on the loan protocol known as Anchor. This protocol allows - for people who deposit their TerraUSD here - to get 20% annual interest. At one point, 14 billion of the total 18 of TerraUSD in circulation were stored on this protocol. "With so much value locked into Anchor, it became clear that most investors were buying the stablecoin for the sole purpose of capturing these attractive interests," CoinDesk writes. According to critics, Anchor's interest rates were unsustainable, artificially maintained by Terra's creators and their deep-pocketed investors. ”

It's a system similar to what, for example, has long held Uber or Amazon: companies in constant loss are financially supported by investors in order to gain control of the market and then be able to start making money. Instead of running below market prices, as has long been the case with Uber, this was an excessively high interest rate used to lure people into Earth's ecosystem, hoping they'd stay there forever.

U-turn Suddenly, however, things went all wrong: perhaps in fear that the game was about to break (and therefore in the more classic financial mechanism of self-fulfilling prophecies), at the beginning of TerraUSD's deposits on Anchor suddenly began to withdraw from 14 billion to 3 billion (and then even less) this week. “Such an emptying of the main TerraUSD hub has probably signaled the total loss of confidence in the project - specifies CoinDesk -. Since the use cases beyond Anchor are limited, the withdrawn money has probably ended up on the market. ”

A portion of the insiders - and Terra's founder, South Korean Do Kwon - think that it was a sort of conspiracy, given the suspicious speed with which all funds began to be withdrawn. And so, even the algorithm of a stablecoin designed to keep the price fixed failed to react in time: on May 10, the value of TerraUSD dropped to 70 cents. The founders of Terra immediately tried to identify the economic resources necessary to keep it afloat, but without success: the next day it dropped again to 33 cents and today, as mentioned, it reached 16 cents.

Due to the relationship between the two cryptocurrencies, the market was flooded with Luna, whose value began to plummet, setting off an unstoppable chain reaction, which effectively canceled out any value of a currency whose capitalization has gone from all-time highs of 40 billion to 200 million now. On the morning of May 13, the value of a Moon - which in the golden age, as mentioned, had exceeded 120 dollars and which in the last month had been around 80 dollars - is 0.00004046 dollars. Nothing.

Attempts to economically save the project by selling bitcoin reserves and through other complex financial systems have failed. During the Italian night, Terra's official Twitter profile announced the interruption of operations on the blockchain and the desire to identify a plan for its reconstitution.

For the world of cryptocurrencies - and in particular of the always suspicious DeFi - it is a bad blow, which risks further undermining the confidence of a sector with great potential, but which regularly falls back into the same mistakes, speculative excesses and real scams. Given the situations that continue to repeat themselves, there is little wonder at the constant skepticism that surrounds this sector.