'Death spiral' and Luna's investor confidence

 Cryptocurrencies like Luna are seen by many as the future, but its ups and downs depend on trust, meaning its value can evaporate in the blink of an eye.



In the middle of last year, Odosa Iyamuosa, 28 years old living in Nigeria, invested $4,000 in savings in Terra Luna on the advice of a friend. He studied the coin closely and realized it had a lot of potential.

The price of Luna then increased sharply thanks to the success of the parallel token, TerraUSD (UST). Big names in the crypto space like Coinbase and Binance also invested in Luna.

For Iyamuosa, Luna is the hope to escape Abuja, where the average salary is 2 USD / day. He aims to increase his savings to $ 16,000, take a data analysis course at a college in Canada, and then apply for jobs in major US technology corporations.

Many cryptocurrencies can lose their value in the blink of an eye. Photo: Bloomberg

Many cryptocurrencies can lose their value in the blink of an eye. Photo: Bloomberg

In the first few months, the plan went smoothly as Luna's value doubled. "I send money to my mother and siblings. I can eat properly," he said.

By mid-May, the value of this token collapsed completely. UST plunged from a fixed level of 1 USD to only 0.03 USD on May 13. Meanwhile, Luna also fell vertically from a peak of more than $100 to just under $0.0002. Both lost a total of $60 billion in market value in a flash.

Iyamuosa said that the amount of cryptocurrency in his wallet is currently worth only 0.03 USD. "I didn't know what to do, I didn't feel like living," he said, but insisted he had no intention of committing suicide.

The skyrocketing prices of cryptocurrencies like Bitcoin, Ether, and Dogecoin over the past two years have caused fear of missing out for many looking to make a short profit. Along with that is the promise of decentralized finance (DeFi), which is said to offer high returns and low risks, removing rigid regulations in the traditional financial system.

But now, social media is filled with stories from investors like Iyamuosa. All admitted to having lost all their savings because of Luna. Even Reddit has to pin a psychological support line to the top of the Terra/Luna topic in the forum.

The collapse of Luna and UST led to a series of virtual assets sold off, wiping out more than $300 billion in market value of many cryptocurrencies between May 7-13. Bitcoin, which peaked at $67,000 at the end of last year, is now only half its value. The entire cryptocurrency world is more volatile than ever.

Faith shakes

The UST stablecoin was released in 2020, but didn't attract attention until March 2021. At this time, Do Kwon, the founder of Terra, added Anchor Protocol, a type of bank used by investors to earn up to 20% by lending Terra digital currency.

Many in the crypto industry consider the 20% figure unsustainable, as it is much higher than the levels promised in many scams. In 2021, the value of Luna will increase more than 100 times and the amount of UST equivalent to nearly 10 billion USD will be created. Kwon declares Terra invincible and disparages those who doubt his ideas.

Even so, UST still has weaknesses. If users lose confidence in the system, they can sell off or exchange their coins, causing others to follow for fear of losing money.

In theory, the Terra system could create more Lunas for people who want to withdraw from the network. But as more coins are generated, the value of Luna decreases, forcing the system to issue more coins and exacerbating the problem. This is what economists call a "death spiral".

"The idea was to make more Luna out of nowhere to secure the value of stablecoins. That doesn't work in practice, it's impossible to make money out of nowhere," said Steven McClurg, chief investment officer at Brentwood. of America, comments.

The crisis started on May 7. Luna at that time was decreasing in value according to the general trend of the market. Later, an investor converted a large amount of UST into a competing stablecoin, causing the price of UST to drop to just $0.99/coin, leading to speculation that Terra's balancing algorithm was threatened. .

Kwon has a billion-dollar Bitcoin fund to back up and is confident in Terra's stability. However, the momentum of UST conversion continued in the following days, forcing the Terra system to generate more Luna.

The price of Luna therefore plummeted, pushing the Terra system into a spiral of death. By the morning of May 13, there were more than 6.5 trillion Luna on the market, making each coin only 0.00001834 USD. Meanwhile, UST is less than 0.2 USD/dong.

Luna cryptocurrency decreased in value after a short time.
Luna cryptocurrency decreased in value after a short time.

Iyamuosa still can't believe what happened a week after the collapse of UST and Luna. In this Nigerian man's wallet, there was about 20 USD left. He still surfs Twitter and Discord every day looking for crypto projects that can make up for lost money. The dream of coming to Canada seemed out of reach.

"There's nothing left for me. I don't know, no more work or anything for me," Iyamuosa said.

Some investors say they've always been mentally prepared for market volatility, but never envisioned a quick collapse.

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