What is actually happening in Terra Luna, and how it will impact other cryptocurrencies

Terra Luna

Hi everyone. Welcome to The Comprehensive Minds. So let me start today’s article by talking about two very interesting data points. So data point one is about the equity performance, or rather the equity performance of top equities in India. These are the top listed firms in India. And over the last six months, you can see that stocks like HUL, HDFC AMC, HDFC bank, and a bunch of other good stocks have corrected quite a lot.

Now let me talk about the second data point. This comes from the US. So here, companies like Amazon have collected by roughly 40% in the last six months. Companies like Apple, which is one of the most stable stocks ever, also corrected by 15%. And if you go down the range, something like Netflix or Zoom, they have been crushed by around 70%.

Now, if you go and try to tally these numbers in the crypto market, something similar is happening. It’s not as if the crypto market is behaving out of wack. For example, Bitcoin has fallen by roughly 50% over the last six months, which is very comparable to the fall of tech stocks in the US. So that is a reality. But there is a lot of panics that is happening due to the evolving situation of Terra Luna.

This is a super complicated topic to explain and understand. I will do my level best in terms of helping you understand what is actually happening in Terra Luna, how it will impact Bitcoin and other cryptocurrencies and regulations going forward, and why right now you should not be panicking, especially if you have not invested in Terra Luna. So let us get that discussion started.

And first and foremost, in order to understand Terra Luna’s story, you need to understand the concept of stable coins and more importantly the concept of algorithmic stablecoins. Now, this is a fairly important concept if you are a crypto investor or if you are against the crypto world. Again, understanding this concept is fairly important because it will help you take positions against cryptos also. So from that perspective, please pay attention. I will try to explain it in super simple language.

What is Terra Luna?

Okay. So first and foremost, you need to understand that Terra Luna is a crypto ecosystem. Now, what do I mean by crypto ecosystem? So cryptocurrencies are an ecosystem. There are NFTs. They can also be tagged in cryptocurrencies. You have Bitcoin and Ethereum, which are blockchain networks. They can be tagged on cryptocurrencies. Similarly, you have Polygon and Solana and Cardano. They are again, cryptocurrencies. So the term cryptocurrency is like a term called the stocks or bonds.

There are thousands of types of stocks. For example, on NSE and BSE combined listing, there are approximately 8500 companies. Similarly, there are thousands and thousands of cryptocurrencies. So Terra Luna becomes a type of a crypto ecosystem and crypto asset. It has three parts.

The first and foremost part is the Terra. It is the blockchain network. So blockchain network is very similar to let’s say Internet, right? It allows you to build more functionalities on it on the Internet. If I ask you that, hey, what does the Internet do? The Internet doesn’t do much. The functionalities that are built on the Internet do a lot. The Internet is a network on which websites are created, blogs are created, et cetera, et cetera.

So Blockchain is basically a network on which additional layers of functionalities are added. For example, Bitcoin and Ethereum, they are all blockchains. Similarly, Terra is a blockchain. Then comes the second part which is Luna, which is the native token and it serves a very specific purpose. I will talk about it subsequently. And then you have the third part which is called Terra UST. So this is the stable coin part.

What is a stable coin?

Now comes the second layer of discussion that hey, what is the meaning of stable coins and why do we need them in the first place? Okay, so let me pick a parallel example and try to explain it to you. So you might have recently read the news or you might have watched that the value of INR keeps on going down by 4%. So it is volatile, so to say. And compared to US Dollar, INR is losing 4% of its value every single year. As of now, you will get scared. You will start reading more about US Dollar and then you will get even further scared because the USD itself is losing value.

So the point is that even Fiat currencies like INR or USD, are also volatile. Right? But what if there was a mechanism that instead of holding your money in cash, you get functionality that you can buy gold? You can buy gold because gold is somewhat of a stable asset. It has been perceived to be a very stable asset and you can exchange that gold as well. So this is something that you can actually do to a certain extent by trading in Gold ETFs.

So when you are buying gold ETFs, why are you buying gold ETFs? You are under the impression that you know that the money that I have, it’s probably going to go down in value and the gold that I possess will go up in value, or at least it will stay stable. So that is the concept behind stable coins.

Now let me contextualize that to the crypto world. That what happens in the crypto world is that even the most stable of cryptocurrencies, they are volatile. For example, Bitcoin is probably the most trustworthy cryptocurrency out there and it is also volatile. Why is that? Because cryptocurrency’s age is almost one and a half decades. So it’s not a very old cryptocurrency. And when assets are new, they are supposed to be volatile.

There is nothing new here. Even the stock market. When it started out in the US, the stock market as an asset class itself was very volatile. So that’s the basic philosophy that right now the cryptocurrencies are very volatile and they need some kind of a stable base, right? So stable base would simply mean that you create a peg. For example, instead of converting your Bitcoin to Ethereum, you convert Bitcoin into a stable coin.

Now, these stable coins are pegged or linked to something. For example, the underlying asset here could be USD, INR it could be euros, it could be gold. So that peg could be literally anything. So I hope you get the functionality of what stablecoins do in a very easy-to-understand language. What they are simply doing is that they are allowing you to bypass the volatility of holding crypto currencies.

So once you purchase Bitcoin, you can convert that Bitcoin into a stable coin without coming out of the crypto ecosystem. Because otherwise then you will have to pay a lot of taxes, a bunch of other different things. So you simply are holding Bitcoin because you believe that Bitcoin is going to go up. You convert that Bitcoin into a stable coin and the stable coin is supposed to be stable in value. It should not move around too much.

USDT chart

For example, here is the chart for USDT, which is a stable coin and it has approximately stayed at one point. So one USDT is equal to one dollar. So just to summarize, if you believe in the narrative that right now Bitcoin is trading at a very low level, I’m going to buy it, and I’m going to convert it into USDT. Do my fixed deposit on board gets like then this becomes like massive money paying investment for you. You don’t need to come out of this crypto ecosystem per se. So I hope all of us understand the functionality of these stable coins.

Now even the stable coins come in very different variants. For example, if I say if I generally tell you that you know what stocks are very good, yes, stocks might be very good, but what type? For example, blue-chip stocks might be very good. But penny stocks or stocks that have no fundamentals might be very bad. So there are different layers of categorizations of stable coins.

Algo-driven vs Nonalgorithmic stable coin

Also, there are two primary types of stable coins that exist. One is called Algo-driven or algorithmic stable coins and the second is non-algo-driven. So let me quickly explain what non-algo-driven stable coins are. So consider for example the most famous stable coin which is called USDT.

Here the mechanism is very simple in order to release one USDT on a blockchain network, the company that is managing USDT needs to buy $1 and keep it in their bank account. Whether that happens, whether that does not happen, that comes out in the auditing process. But this is what the fundamental concept behind non-algo stable coins is.

There is a party that is managing things at the back end and they are taking care of this, pegging that every time a USDT is released on a blockchain network, one USD has to be purchased. That’s the simple rule there.

Now comes algorithmic stablecoins. Now algorithmic Stable coins are a very interesting topic here. What happens is that you are interacting with a smart contract. So there is no human at play here. It’s not as if every time one Terra UST or UST, which is another type of algorithmic stable coin is released onto the blockchain network, someone at the back end is managing that process. It is not managed by people, it is managed by a piece of a smart contract.

So therefore they are called algorithmic because there is an automatic buying and selling happening as per a smart contract. So that is the difference between algorithmic stablecoins and vis-a-vis non-algorithmic stablecoins.

How Terra Luna functions

So what happens is that if the price of one UST is greater than one dollar, what is UST? Ust is the algorithm of a stable coin in the Terra Luna network. So that is what you need to remember that if the price of USD is greater than one dollars, then what is going to happen that ideally the mechanism or the smart contract should have balanced it out to an extent. That UST will become exactly one dollar.

So here what Terra Luna allows you to do is that it can sell Luna to the blockchain network Terra. So you remember the first three parts Terra is the blockchain, Luna is the native token and UST is the algorithmic stable coin. I know it is complicated but this is the simplest explanation that you will find. So anyways, moving on.

So basically what is happening is that the UST price has gone up more than a dollar. So UST price needs to come down. How will the USD price come down if the supply of UST is increased very similar to onions, right? If the onion price has become $10, when will the onion prices go down? When the supply of onion increases and there is too much onion in the market, then it will come from $10 to probably like $1.

So something similar happens in the Terra Luna ecosystem as well. That when the UST goes up beyond the dollar, the ecosystem allows you to sell Luna to the blockchain Terra and then Terra releases more UST. And as a result, the UST supply increases, and this game is played out and the opposite happens when the UST is falling.

But to cut a long story short, this algorithmic stable coin up until this point was working very, very well. Now there is a relevant piece of history that you need to understand. So, therefore, when I wrote an article on my website earlier about stable coins. I did not speak about algorithmic stable coins because they are dangerous.

Two of the major projects in the Algo Driven stablecoin space have failed. These two projects were Titan and Iron Finance. They had failed in the past, but up until this point, Terra Luna was working wonderfully well and it became one of the top 15 cryptocurrencies in the world. Why? Because this entire mechanism and the smart contract were functioning really well. So then what happened? Where did the story go wrong? And why is it that Terra Luna now has lost 97% of its value as we are speaking?

Fall of Terra Luna

So for that, you need to understand the dark realities of short selling. So these are viewpoints that have been expressed by Charles Hoskinson. So this has not been proven yet and it’s very difficult to pin blame on investment banks. But this is what the conspiracy theory is. You can call it fact, you can call it fiction, but this is what is happening.

And at the back end, I also believe that this story is true. Charles Hoskinson is a very well-respected name in the crypto community and Charles Hoskinson would not make these types of allegations without having some kind of a backstory here. So I’ll explain the backstory. So that will help you understand the Terra Luna crisis.

So far we understood the story that one UST needs to be equal to $1. And as far as that game is laying out, everything is hunky Dory. But if we get to a situation where people are not buying and selling UST or Luna, it becomes a problem. And this can happen when there is a large part of the network or the Luna network or the native coin, gets controlled and there is bulk flushing of those coins.

Terra Luna

So here was a post that was done by Ruben. So I’m picking up data that he has outlined and he has credited this to Charles Hoskinson who is the founder of Cardano. So please pay attention to this. This is a story that is evolving as we speak. So the story goes like this, BlackRock and Citadel. So BlackRock is one of the biggest asset management companies in the world. They actually control a large part of financial transactions as probably the biggest asset management company in the world.

So they borrowed 100,000 bitcoins, So they borrowed the money, these two big asset management companies. And then they swapped 25,000 bitcoins into the Luna network. So they simply exchange Bitcoin into Luna. That’s it, right? So they are trying to increase the supply of Luna. Then they called the founder of Terra Luna Do Kwon and told him that they wanted to sell a lot of BTC for USD. So basically they were saying that you know what we trust in your network, and we want to make an even bigger investment.

We have a lot of BTC. So if we sell it, it will crash the crypto market and your currency will also come down with it. So they convince him hey, how about you buy a large block of BTC and we will buy your native token Luna from you. So that will be an easy-going exchange. It will not derail the markets. And unfortunately, the founder believed in this transaction.

Now the moment these big parties got access to a huge amount of UST in one go, what was the equation? The equation was one UST needs to be equal to one dollar. They give this power to an organization that could short-change this, right? So what is the mechanics behind it? It’s very hard to explain. But how does short selling exactly happen? But what happens is that there are price jerks. So what do I mean by price jerk and very easy to understand language. It means like this.

For example, if you and I go and buy, let’s say 1000 shares of ITC, it will not move the needle. The stock will hardly move. It will move. Like maybe like let’s say 1% hypothetically speaking. But if suddenly Warren Buffett decides to buy like these many number of shares of ITC, if that is at all possible, then the price will become rocket in an instance itself. Then the opposite happens that if there is a big whale that is selling stuff in one go, then the price of that particular asset will go down quite aggressively.

So that is what precisely happened when these big asset management companies gain access to a huge amount of UST. They bulk sold those and on 9th May, 1 UST became $0.68. Now this became an opportunity for other big whales to jump into this entire mix and start exploring some arbitrage opportunities.

So if I explain further, we’ll go deep into trading concepts then. So I don’t want to get there. But I hope you get the core message that once this mechanism was instituted, it just became a problem for Terra Luna to stabilize that smart contract and it started falling quite aggressively.

Why did Bitcoin fall?

Now comes the obvious question hey, why is it that even the most stable cryptocurrency, which is Bitcoin, has fallen by roughly 4% in a day? So honestly, that’s not a big fall in the crypto market. That’s part A, part B, Bitcoin is likely to take a hit if there is any type of major hit taken by other major points because Bitcoin acts as a sentiment mover in the crypto space. So therefore a lot of investors are panicking in the crypto world. They are selling their cryptocurrencies if they have purchased them without understanding why they have purchased them.

And now we are in a stage where only fundamental investors who truly believe in this asset are going to stay put. Am I staying put? Yes, I have not sold anything and I’m going to stay put again. Please do your own due diligence. If you believe in cryptocurrencies then only go to it.

The second key reason why Bitcoin is falling a little bit is fairly simple a lot of arbitrage opportunities have come up. People are seeing this as an opportunity to short the crypto market so therefore they are shorting Bitcoin also and it becomes a problem from that angle.

What is the way forward?

Is Bitcoin going to survive? Our good cryptocurrency is going to survive so my bet is yes, I’m still very much bullish. I’m exactly as bullish as I have ever been. Why? Because you need to understand the fact that 99% of cryptocurrencies are bad. believe in those cryptocurrencies they are likely to survive. Now comes the fourth point which is stable coins. Sensible or not stable coins are much needed. They are needed in the crypto world and good stable coins are going to survive.

But now there is an add-on risk even on nonalgorithmic stable coins. For example, something like USDT is likely to get regulated very quickly now. There are a bunch of senators in the US, for example, Senator Warren who will pick up these types of events as an excuse to start regulating cryptocurrencies more, and the stable coin is where the cryptocurrency market will start getting regulated and for the right reasons, stable coins should be regulated.

They should be heavily regulated because that will improve the audit process. Lastly, what is it that you should be doing? According to me, I will continue to invest in good cryptocurrencies. Please do your own due diligence because think about it, think about it from a macro viewpoint, cryptocurrency price movement behave exactly like growth tech stocks. So if something like Netflix, if something like Zoom, if something like Coinbase, if something like other companies has fallen quite a lot it is not a sore thumb that cryptos are exhibiting.

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