What happened with Terra Luna?
Updated: Nov 2, 2022
The second quarter of 2022 was characterized by two shocking events (the collapse of Terra Luna and the ban of Celsius Network) that have contributed to the market down and continue to influence the crypto industry. In this article, we’ll go deeper about Terra Luna, analyze its functioning, token system, the new project, and why did Terra Luna collapse, causing a crash in the entire crypto market.
What is Terra?
Terra is, or it would be better to say, "was" a permissionless blockchain hosting an ecosystem of decentralized applications (dApps) that uses Cosmos SDK, the world's most popular framework for building application-specific blockchains. Founded in 2018, in South Korea, by Do Kwon and Daniel Shin, it allows users to create stablecoins pegged to fiat currencies through the consensus mechanism Delegated-Proof-of Stake (DPoS) using smart contracts. The main goal was to create a secure payment system using a decentralized algorithmic stablecoin that could be converted into its native token, LUNA, without over-collateralized cryptocurrencies or fiat currencies. In a nutshell, the founders wanted to stabilize TerraUSD (UST) using LUNA, so 1UST was worth $1. The stablecoins on the Terra network use a different method to maintain the peg compared to the collateral stablecoins that use fiat or other cryptos. The latter allows those who own them to exchange their stablecoin with an equivalent amount of fiat or cryptocurrencies (e.g., BUSD of Binance and DAI of MakerDAO). LUNA is the Terra protocol’s native staking token. It is used to pay the network’s gas fees, participate in governance procedures and staking, and maintain the anchorage with its associated facilities, TerraUSD(UST).
The collapse of Terra
To understand what led to the collapse of Terra’s algorithmic stability and its LUNA token generating the so-called black swan event, you must first understand all the stages that characterized the event.
The peg loss. On May 7th, TerraUSD (UST) lost its peg to the dollar for the first time, following a swap that created an imbalance in liquidity. Due to deficits, the liquidity providers began to sell UST elsewhere. For this reason, stablecoin has lost its peg on other exchanges;
The peg loss reflects upon TerraUSD. With the peg loss, the price of LUNA marked a sharp drop to undermine trust in UST stablecoin. Not all holders could redeem their $1 of UST for $1 of LUNA.
Stop the network. With the liquidity pools almost wiped out, UST’s holders were forced to redeem UST for LUNA. Unfortunately, the supply growth has pushed prices below one-hundredth of a dollar, so Terra stopped its blockchain operation on May 12th.
Why has Luna crashed?
In a few words, social media platforms like Reddit and Twitter were pestered with countless crypto holders' comments. The Luna token had crashed from a price of around $120 per $LUNA to less than $0.02 within 48 hours. This was a significant record of loss in the crypto industry. Subsequently, its dollar-pegged token $UST was also depegged, and its value dived from a dollar to a few cents. On the 12th of May 2022, a series of exchanges announced the delisting of $LUNA and temporarily suspended both the withdrawals of $LUNA and $UST. In the following days, the CEO of Terraform Labs proposed a solution for the depegging of $UST and devaluing of $LUNA. A $1 billion $UST burn would decrease the supply of UST and restore the stablecoin's peg. In the meantime, more people were buying $LUNA partly because they believed in the ability of the token to bounce back and partly to reduce their financial losses.
But that wasn’t enough, so founders and the community started plan b, the genesis of a “hard fork”, a new chain called Terra 2.0.
A new Terra
The community voted for a rescue plan that led to the creation of a hard fork.
“On May 25th, 2022, Terra Classic users passed governance proposal 1623, which outlined the genesis of a new Terra chain. This proposal also described a genesis distribution of Luna, which would be airdropped to users of the Terra Classic chain based on pre-depeg and post-depeg snapshots. Users can find their airdropped Luna by viewing the same wallet address present during either snapshot and switching their Terra Station network to the phoenix-1 mainnet. On May 27th, 2022, the phoenix-1 Terra mainnet launched, ushering in a new era of development by the Terra community.” Terra Doc
As a result, Terra’s original blockchain was divided into two separate chains:
Terra 2.0, with the new native LUNA token (also known as Luna2). Terra 2.0 will inherit the original chain's developer pool and user base without the UST algorithmic stablecoin. Before the collapse, the new tokens were assigned to the wallets containing LUNA and UST tokens.
Terra Classic, with Luna Classic native token (LUNC), is Terra’s original blockchain. It will coexist with the new chain (Terra 2.0) and will be supported by the part of the community that disagrees with the revival plans and with the fork. The name is a tribute to Ethereum Classic.