Over the last decade, cryptocurrencies have been improving the way businesses have operated, for example, by developing new contracts and even building modern payment tools that have become increasingly available on the financial market and are actively used in payments and investments. 

However, unlike the ordinary currency, such as dollars, euro, or yuan, whose exchange rate is highly dependent on inflation, politics, and other economic conditions, and therefore the calculations of the exchange rate can be performed more accurately, the value and the fluctuations of the cryptocurrency are more difficult to predict. 

Knowing the risks involved in cryptocurrency investments and taking the right position in trading and investing aimed at getting the greatest benefits for the investors is a difficult task. 

An intelligent investor must know that, similarly to the stock investments, the important factors in the evaluating and pricing of cryptocurrency are the interaction between supply and demand, the attractiveness for the investors, the macroeconomic conditions and the financial events. Unfortunately, some investors heavily rely on the speculation and the rumors that drive cryptocurrencies. Therefore, because of these factors, investing in cryptocurrencies is of high risk. 

However, some cryptocurrencies are becoming well known for their role in developing new ideas in the market, therefore creating business opportunities and wealth. For example, for the last six months before its lost value, investors have been putting their trust in investing in cryptocurrency Terra UST for a reason: to profit off a borrowing and lending platform called Anchor, which offered a 20 percent yield to anyone who bought Terra UST and lent it to the protocol. 

When this opportunity was announced, many investors immediately found it as an attractive investment opportunity. Unfortunately, this kind of investment is considered to be an investment fraud that promise bonuses to an existing investors with funds collected from new investors. In reality, it was mathematically impossible for Terra to give such a high return to all of its investors. 

Terra and Luna Crash

At the time when the United States Federal Reserve and central banks globally hiked interest rates aggressively and removed trillions of dollars worth of COVID-19 stimulus, in a desperate attempt to slow down high inflation, on May 13, 2022, the global market witnessed a stressful time for cryptocurrency investors who own bitcoin and other cryptocurrencies, as they watched billions of dollars get wiped off the value of their assets.

The major cryptocurrency, such as bitcoin, which has often been described as digital gold or a hedge against inflation, plunged below 25.5 USD, the decline from the record high 69 USD price tag it commanded back in November 2021. Leading the wider cryptocurrencies, which include thousands of digital currencies and tokens, have seen their value plunged by more than 50 percent in a short time.

Terra was one of the world’s most valuable and stable digital currencies. But on May 10, 2022, a huge sell-off occurred as the value of the Terra stablecoin suddenly unpegged from the United States dollar. Its value plunged from 1 USD (where it was always remained) to 60 United States cents. Then it crashed again on the second day, bringing its value down to 20 United States cents, losing 80 percent of its value.

How Terra Plunged

Most stablecoins are backed by cash reserves, and they’re supposed to have enough liquid assets on hand to match the value of each coin.

Cryptocurrency traders use stable coins as safe havens hedge when markets in Decentralized Finance DeFi lose its value. Instead of converting their more volatile assets into hard cash, which can be expensive and trigger tax implications, traders simply trade them for stable coins. 

Some stablecoins derive their value from being fully backed by reserves: if investors decide they ever want out, the stablecoin’s foundation should theoretically have enough cash on hand to repay all of them at once. Terra UST, on the other hand, is an algorithmic stablecoin, which relies upon code, constant market activity, and sheer belief in order to keep its peg to the dollar. Terra UST’s peg was also theoretically supported by its algorithmic link to Terra’s base currency, Luna.

More specifically, Terra UST is an algorithmic stablecoin whose value is backed by a sister token called Luna, which is run on pre-programmed smart contracts. In a scenario that Terra’s value decreased below 1 USD, it can be swapped for Luna tokens at a small profit. Therefore, theoretically, that’s meant to keep the value of both coins stable.

Unfortunately, Luna somehow crashed at the same time as Terra UST, in a dramatic way.  Essentially, investors rushed to liquidate their digital assets quicker than the algorithmic stabiliser could take effect.

The price of the sister token, Luna, dropped from about 86 USD on May 10, 2022, to 0.003 United States cents on May 13, 2022, a dramatic crash within two days. In other words, Luna has collapsed and lost nearly all its value in a shorter time.

Investors suffered unprecedented losses as Luna’s market value plummeted from 40 billion USD to about 500 million USD, which led to a sell-off and crisis of confidence across the wider cryptocurrency market. The great question of what caused Terra and Luna’s price to crash remains unanswered.

What Are the Lesson Learned

Perhaps the most critical lesson from the event of Terra is that cryptocurrency markets are highly volatile and unpredictable. The cryptocurrency market struggles have been more exacerbated by the demise of Terra that worth 60 billion USD project.

The project of Terra UST, a stablecoin, fixed its value to the United States dollar, which its supporters hoped would promote traditional payment systems across the world. But it was wiped out in the short time when investors panicked and tried to pull out their money, causing a collapse in the cryptocurrency financial system. The crash bankrupted many investors and pulled down the entire cryptocurrency market: over 400 billion UDS was wiped out in terms of cryptocurrency market capitalization.

Comparably, similar even, with less damage, happened in the exchange market, in which Netflix shares declined to their lowest point since 2018 as investors reacted to the company’s first subscriber loss in more than a decade. The Netflix stock closed down 35 percent on April 20, 2022, to 226.19 USD per share, marking Netflix’s biggest loss in a single day only. The company shed 54.4 billion USD in market capitalization overnight, the largest single-day decline in its history.

Back to cryptocurrency, Terra investors were the ones who most immediately lost their investments; its downfall may have both short-term and long-term ripple effects for cryptocurrency and beyond, especially as skeptical investors, legislators, and regulators survey the damage. People have lost their investments through cryptocurrency investments, and there aren’t enough protections in place to safeguard consumers from these risks due to the lack of regulation.

Although cryptocurrency investment provides new opportunities, investors must be cautious when investing in cryptocurrency. Cryptocurrency market has a lot of scammers and frauds, which are causing loss of investments, as in the case of Terra UST.

 

To learn more about the cryptocurrency  and other investments, you can purchase THE FIRST INVESTOR book and receive a discount by clicking on The First Investor   .