Why Did Terra Fall To Zero? Terra Scam-All That You Need To Know

Last updated on March 3rd, 2023 at 01:04 pm

Introduction

As if the crash of the Crypto market was not enough, a phenomenon known as a Blood Moon occurred briefly early on May 16th, 2022.

Anyone who had put money into the LUNA cryptocurrency must have thought this was a cosmic joke. Just a few days before, the original asset of the Terra blockchain fell from $80 per token to less than $1 per token. This caused a $40 billion loss in value and was called “Mt. Gox 2.0.”

The fall of LUNA is worse for cryptocurrencies than the failure of BitConnect and the market crisis in March 2020. It is the worst time for cryptocurrencies since the Mt. Gox exchange closed in 2014 because of an insolvency event.

We will talk about what happened to Terra and what is the Terra Scam about here in this article.

Terra Success

“I believe the basic issue that drove Terra’s first success is also what led it to a catastrophic disaster,” asserts Victor Young, Chief Architect at Analog. “I believe the key issue that drove Terra’s initial success is also what led it to a catastrophic catastrophe.” “According to the whitepaper for Terra, its inventor, Do Kwon, aimed to create a stablecoin infrastructure superior to Bitcoin for payments and sturdy enough to compete with Ethereum’s decentralized application (dApp) ecosystem.

This meant that a stablecoin product had to be made that could compete with fiat currencies in the normal marketplaces. Unfortunately, there was a lack of openness throughout the entire endeavor. But who knew it would lead to a total disaster called the ‘Terra Scam’ one day?

The proverb states that you won’t know who’s been swimming nude until the tide goes out since only then will they be exposed.

As the water level in the Terra ecosystem started to go down, leaving LUNA holders high and dry, it was found that many people who should have known better were swimming in the Terra ecosystem without clothes on.

To use a common slang term, investors of all kinds were “rekt,” from hedge funds to people with a lot of influence.

However, the cryptocurrency industry is nothing if not capable of reinventing itself. In the aftermath of Terra’s death, prominent luminaries have sworn to learn from the failings of its predecessor and guarantee that history cannot repeat itself.

The catastrophe, initiated by the malfunction of Terra’s algorithmic stablecoin UST, resulted in a “death spiral” that reduced the dollar-pegged asset to a few pennies and caused the value of the LUNA token to drop by 99 per cent.

Crypto Failure

Many people working in the cryptocurrency business believe that the project’s failure-opportunity to de-risk and develop more resilient systems that can resist severe economic shocks.

Those politicians and regulators driven by consumer protection and market stability mandates who have set out to control cryptocurrency will find this too little or too late.

The fact that a synthetic derivative can even call itself a stablecoin shows that there isn’t a strong enough industry standard for stablecoins to protect consumers.

This is likely to make regulators who want to regulate stablecoins even angrier. In contrast to a synthetic fiat peg maintained by an algorithm with a lack of transparency to high-risk underlying assets, the name “stablecoin” suggests that stability may be achieved through asset-back reserves or fiat currency, both of which carry a low level of risk.

“To the vocal critics of Terra’s algorithmic design – you were right, and we were wrong,” wrote a contrite Delphi Digital, whose investment arm lost $10 million.

“We understand the risks of the algorithmic model upfront and sought to be transparent about them throughout; however, it’s clear we miscalculated the risks”

In 2018, Preston Byrne, partner at Anderson Kill and one of crypto’s preeminent legal beagles, called out algo stablecoins with Basecoin and Base Protocol, the predecessor to Terra, and came to the brief conclusion that “this is an exceedingly bad idea.” Terra is a cryptocurrency that uses the Terra protocol.

How did the Terra Luna Scam spiral begin?

The past of algorithmic stablecoins, crypto-assets tied to the dollar but not backed by fiat currency, is long and tainted.

Every attempt made up until this point to develop an “algo stable” has been unsuccessful owing to the difficulty of developing a token that can maintain a death grip on 1 USD even when subjected to strong sell pressure.

The only stablecoins that can avoid a negative outcome by forbidding the burning of coins and minting new coins are those safeguarded by over-collateralization.

According to Shahaf Bar-Geffen, CEO of COTI, “under-collateralization is the common denominator when it comes to stablecoins debugging.” “We saw it happen with UST and now DEI [another algorithmic currency that also lost its peg],” Bar-Geffen says. “We saw it happen with UST and now DEI.”

UST, Terra’s algorithmically regulating stablecoin, was designed to be unique and maintained that distinction for a considerable time. Twelve months ago, the LUNA token was trading for less than $5; however, when the cryptocurrency bull market began to kick into high gear, the price of LUNA skyrocketed, bringing the Total Value Locked (TVL) on the network to billions of dollars.

At the beginning of April 2022, LUNA achieved its all-time high of $116, which generated massive gains for its early investors.

Terra as a low-risk alternative

Terra’s UST stablecoin was seen as a low-risk option for savers. This made it appealing to investors from all walks of life, including people with a lot of money, parents, and even young children.

The highly speculative LUNA token was used as collateral for the Anchor protocol’s UST, which offered a handsome payout of twenty per cent.

Unfortunately, UST has mislabeled a stablecoin as its growth was fueled by greed, excessive leverage, and a massive cash burn financing its nearly 20 per cent risk-free rate, as Alkemi Network Co-Founder Brian Mahoney says in his Terra post-mortem. “Unfortunately, UST has mislabeled a stablecoin as its growth was fueled by greed,” Mahoney says.

Collapsing Terra Luna

Experienced crypto watchers would confirm that the code’s quality and the incentives’ longevity are the two most important factors in determining the success of a project over the long run.

Talented developers were working on Terra, but the network incentives seemed questionable.

Critics began discussing problems with the UST’s algorithmic approach as early as 2021 and pointing out potential entry points for attacks.

On May 7, the prophecy was fulfilled when the Terra network fell victim to the attack that the Terra network’s critics had been predicting for a very long time.

The verdict is still out on whether it was a concerted effort by wealthy whales or the action of a lone wolf, but one thing that cannot be disputed is that the UST’s economic model was a disaster waiting to happen.

The dollar peg fell to $0.98 after a wealthy player carried out a significant sell-off of UST using the Curve protocol, and this was just the beginning of the chain of events.

Do Kwon, the figurehead of Terra and a messianic leader who is not known for his humility, dismissed the event as being nothing more than a speed bump, but a deadly blow had already been dealt.

Even the sale of Luna Foundation’s substantial Bitcoin holdings was not enough to bring the UST peg back to its previous level. Terra scam also contributes to the fall of Terra.

The fundamental reason behind the fall Both UST and LUNA decided to start a race to the bottom of the rankings over the following five days.

James Taylor of CeDeFi exchange Unizen says that the main reason Luna failed was that it was hard to manage the UST peg across both centralized and decentralized trading venues. “The attacker cleverly chose Curve stable swap to attack the protocol, which imposed the maximum damage and incited panic”.

Diving deeper after the collapse

“When hundreds of thousands of people collectively lose billions of dollars through a DeFi app promoted as a safe savings account rather than a risk-on investment, by some of the biggest and most reputable names in crypto, regulation is most definitely on the way,” predicts Kene Ezeji-Okoye of Millicent.

Ezeji-Okoye adds that “although it may come as a surprise to many, there are some key industry players, like FTX’s CEO Sam Bankman-Fried and the U.K.’s Financial Conduct Authority who know that smart regulation might just be the only thing that can save crypto from itself and truly catapult the sector into the mainstream.”

The people who owned LUNA and UST bonds were hit the hardest by the breakdown, but bigger macro factors set off the chain reaction.

Benjamin Bilski, the chief executive officer of a German financial technology company called NAGA Group, adds, “We are seeing a domino effect where the global supply chain instability is leading to excessive inflation and, in turn, the high volatility of the crypto market.”

Terra scam- Terra Luna crypto scam

After discovering that 74% of Terra USD coins are locked up in the anchor protocol, a Twitter user going by the handle “DeF I Made Here” voiced his view in a post on April 7, 2022 about why this makes Terra USD not a decentralised stablecoin.

Using the anchor mechanism, customers may secure an annual income of up to 19.4 percent on their Terra USD holdings. He believed that the current high returns are subsidised and should be kept that way until Terra USD achieves widespread acceptance, widespread network liquidity, and sufficient reserve accumulation to preserve the peg to Luna.

He warned that the large yield on Terra USD is offset by the fact that there is now no liquidity on the market to liquidate Terra USD investments.

On April 9th,2022, a Twitter user called Jack Niewold began contributing to the conversation by pointing out certain questionable practises the Lunar Guard Foundation had previously engaged in to crack the top 10 cryptocurrency rankings.

Inflationary pressure on Luna is being caused because part of it is being utilised to buy Bitcoin instead of being burned during currency exchanges with Terra USD.

Sell pressure on Luna and a subsequent decline in price is being caused by the reinvestment of funds from the 7 billion USD in earnings and the 3 billion USD raised in the initial coin offering (ICO).

Do Kwon’s personal wallet, which reportedly is not even a multisig wallet, receives profits before they are burnt. Finally, Terra Luna created a stablecoin called UST with a value of $1 billion US dollars, despite the fact that it is not backed by anything tangible.

The Vulnerable StableCoin

The criticism that has been levelled against Terra has not just been focused on the computational flaws present in its stablecoin; the arrogant behavior of Do Kwon has also been called into question.

Victor Young of Analog says that Do Kwon shut down critics who pointed out flaws in the stablecoin’s algorithm. “He even criticized an economist for being impoverished,” Young says of Do Kwon. “He even mocked an economist for being poor.”

Any discussion of what brought about the collapse of UST must consider that the stablecoin was not linked to any traditional kind of collateral. Instead, it used a paired token system that let users trade Luna for UST and vice versa at a guaranteed price of $1, even though this system was based on a consensus method that was both ineffective and easy to manipulate. Terra scam also contributes to the fall of Terra.

Regarding the future of cryptocurrency, market analysts anticipate a continuation of the recent downward trend in conjunction with a stampede toward established cryptocurrencies like Bitcoin.

“We may see a big shift in dominance in favour of both Bitcoin and Ethereum,” said Ben Caselin, Head of Research & Strategy at AAX. “And while turbulence could drag on for weeks, a renewed focus in the market on quality, decentralized networks over frivolous coins and risky experiments can be incredibly bullish for the one asset that started it all, bitcoin,” he added.”

The Future

The dramatic failure of the Terra network has been tough to swallow for the software developers, application creators, platform operators, and users who once considered Terra their home.

Some people have decided to leave the failing ecosystem and establish themselves somewhere else, maybe on Cosmos, a community-focused network that has reached out to Terra’s displaced developers.

Not many choices could work out for Do Kwon and his tight-knit group. The first option is to start from scratch and rebuild Terra, but this time without the algorithmic stablecoin, which could be a time bomb.

Another question that has to be answered is whether or not this can be accomplished and whether or not anyone in the ecosystem or market will have faith in a rebuild.