The collision between Terra and Luna shines light on future investments
One of the newest digital currencies, Luna has shocked everybody, not for good reasons. It shot from $1 in 2019 to nearly $120 in 2021. It grew so positively, but the coin lost ALL its value in less than a month. Why did a $2.5 billion capitalization asset crash that quickly? Let’s see:
Luna is a pegged asset, which means that Singapore’s Terraform Labs (STL) — the company that creates it — uses Luna as a backup for another digital currency: Terra.
Terra is the stable coin, that Luna protected in theory, similar to the way that the Fed used to save gold to guarantee the value of the dollar. If holders want to sell their Terra coins, STL pays the value with Lunas.
Why was this model so popular?
- Terra’s price was equal to US1
- Terra offered 20% revenue to people who invest
STL was making a lot of money selling those two cryptocurrencies. Luna’s price skyrocketed to the moon. Everybody wanted the dollar-backed crypto with the 20% revenue.
BlackRock and other investors noticed that Terraform Labs would not be able to pay the dollar value in the future. They borrowed Terras because they expected that the prices would drop, so when they returned them, they earned the difference between the borrowed price and the real price, aka they short-sold Terra.
The BlackRock strategy forced STL to create a lot of Lunas in order to pay the total dollar value. Luna’s price plummeted as did Terra’s, because their values were no longer supported.
Following this lesson, investors think that just a few digital coins will survive. Bit coin is still the strongest, with a $550 billion market cap. Here are some lessons from the faulty Luna/Terra experiment.
- Stable reserves for coins: If investors want stable currency, the pegged asset should be stable. If the pegged asset is as volatile as Luna, sooner or later the system will fall.
- Choose big projects: Those two coins crashed, not just because of Luna’s volatility but because of speculation. The market capitalization was not big enough to resist. For example, Ethereum is a stable asset tethered to the coin DAI. Ethereum capitalization is over $200B, so funds cannot short them dramatically.
- Empty promises: Investors will run away from “strangely high guaranteed profits” to opt for real profits.
As George Soros said: “Mister Market is a schizophrenic in the short term, but he regains his sanity in the long term”
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