Welcome to our guide on the Luna cryptocurrency. Not long ago, Luna was a top 10 cryptocurrency but after failing one of its primary functions, the digital asset saw its price capitulate and lose over 99% of its value in just three days. If you want to learn more about this monumental upset in the world of crypto or are wondering ‘Should I buy Luna now that the price is low?’ then you do not want to miss this guide!
VCs and hedge funds were lining up to buy Luna, but when the technology failed the project quickly went from hero to zero. Today’s guide will cover everything from how does Luna work to reasons for the price crash and its prospect for redemption within the mass adoption of crypto. Let’s get started!
Terra-Luna Ecosystem
Luna is the primary native asset on the Terra blockchain which launched its mainnet in 2019 and is spearheaded by founders Do Kwon, Daniel Shin and the Terraform Labs development company based in South Korea. The Terra blockchain was created on the Cosmos SDK framework, an advanced tooling framework designed for the creation of secure, interconnected blockchain ecosystems. Luna is but one component of the Terra ecosystem which grew into one of the leading DeFi (decentralized finance) protocols in the crypto space (until the recent collapse, that is). The names ‘Luna’ and ‘Terra’ are often used interchangeably but they actually refer to two distinct things and to understand the former, you must also understand the latter. We will also look at the wildly popular Anchor protocol and Terra’s algorithmic stablecoins.
Terra Blockchain
Terra is a blockchain protocol responsible for recording and securing all transactions on an immutable digital ledger to protect digital assets. Terra uses a proof-of-stake consensus mechanism similar to other successful blockchain protocols such as Cardano and Polkadot. Proof-of-stake uses significantly less energy than the proof-of-work mechanism utilized by Bitcoin and Ethereum, which made the Terra blockchain a more environmentally-friendly option, VCs and hedge funds could buy Luna without damaging their ESG reputations.
Terra is substantially faster than the aforementioned protocols, clocking in 1,000 tps (transactions per second) compared to the estimated 7tps on Bitcoin and 20 tps on Ethereum. If speed is your thing, however, you might be better-off if you buy Solana which boasts a lightning fast 65,000 tps, but we digress. Terra is the blockchain infrastructure on which other defi applications are built and operate. This ecosystem has been fast-growing as the Luna token has taken off in popularity and value. The Terra blockchain now has one of the most advanced tooling kits in the entire COSMOS ecosystem, which makes it easier for developers to integrate their systems with Terra and build dApps that incentivize people to buy Luna for utility in applications.
One of the main functions of the Terra blockchain is to serve as the payment railway for algorithmic stablecoins, of which TerraUSD(UST) is the most popular. There are also stablecoins for national currencies other than the US dollar, including the South Korean Won and the Euro. Algorithmic stablecoins on the Terra blockchain are designed to hold parity with respective currencies. What differentiates Algorithmic stablecoins from standard stablecoins is that they are not collateralized by reserve assets, and this was a major contributing factor to Luna’s downfall. More on this in the section on stablecoins.
Luna Token
Luna is the primary native currency on the Terra blockchain and serves three primary purposes, it can be programmed by dapps on the blockchain to serve a number of different purposes but these three are what makes the Luna token valuable. Firstly, it is used to pay for payment processing fees on the Terra blockchain, this ensures that there is always a demand for the token within the ecosystem. Basically someone has to buy Luna in order to make a transaction on the Terra blockchain, it should be noted that these fees are very small, generally close to or below $0.01.
Secondly, it serves as a governance token within the blockchain thereby giving holders voting rights on fundamental aspects of the protocol’s future development. Lastly, and most importantly, Luna is instrumental in helping its algorithmic stablecoin, TerraUSD (UST), maintain its peg to the dollar. Algorithmic stablecoins on the Terra blockchain are counterbalanced by the minting and burning of Luna tokens, into and out of existence.
If anyone wants to mint $1 worth of UST stablecoin they must burn $1 worth of Luna tokens thereby reducing the supply of Luna tokens. This made Luna a deflationary token whereby the supply systematically decreased as more UST was being minted. UST maintains its peg through arbitrage and Luna trading, people stand to profit from exploiting price discrepancies whenever the stablecoin momentarily loses its peg -this is usually within a $0.02 window.
The deflationary nature of the Luna token applies upward price pressure which incentivizes people to buy Luna as a long term store of value asset. In the end it was a relatively simple combination of features that made the Luna token so desirable to hedge funds and VC’s but without a doubt it was the Anchor protocol that was the icing on the cake for the Terra ecosystem.
Anchor Protocol
The technical capabilities of the Terra Blockchain and the deflationary nature of the Luna tokens does not seem to be what initially lured so many to buy Luna or to start Luna trading. What attracted investors to invest in Luna rather than buy Avalanche or buy Cardano is the opportunity to generate astronomical yields using the Anchor Protocol, yields that were not available on these competing protocols. The promise of a stable 19% APY by lending on the Anchor Protocol saw many investors, including higher profile hedge and VC funds, rushing to mint the UST stablecoins to earn absurdly high interest without volatility (thanks to the stablecoin peg). But how could Anchor Protocol justify paying out these rates?
It appears as though Anchor Protocol did not intend to maintain these rates indefinitely, instead a grace period of high rates would serve as an entry point for new investors who, it was hoped, would stay with the protocol even after rates were reduced. The Anchor protocol funded these rates by siphoning off their reserve warchest which they amassed during their initial funding rounds. The reserves however diminished as adoption grew exponentially.
Anchor brought many new users to the Terra Platform, users who would also buy Luna or mint UST, which burns Luna and reduces its supply. These factors are what made Luna one of the fastest appreciating assets of 2021. Naturally, the founders were loving the adoption that Anchor brought and thus the Luna Foundation agreed to top-up the near depleted reserves with an additional $1 billion, but it soon became clear that this was absolutely unsustainable.
Where it all went wrong
To get a grip on the major Luna meltdown, we first need to understand why a badly designed algorithmic stablecoins presents a systemic risk to any protocol and why Luna’s bet on Bitcoin exacerbated their downfall.
What are Stablecoins?
Stablecoins are cryptocurrencies with monetary policies that aim to keep their prices ranging within a very narrow window of another asset’s price, usually a national currency. The most popular stablecoins at present are TetherUSD (USDT) and CircleUSD (USDC). Both USDT and USDC are pegged to the US dollar and are extremely important for the cryptocurrency ecosystem as the dollar is highly demanded and widely accepted, so it works well as a medium of exchange and unit of account for online crypto trading.
Stablecoins are the gateway to crypto for all beginners. Newcomers wondering ‘How can I buy Luna?’, will find the first step after signing up to an exchange would be to buy a dollar backed stablecoin such as TetherUS. This stablecoin crypto can then be used to buy Luna or buy Ethereum or any crypto the exchange has on offer. There is not enough liquidity between most cryptocurrencies for trading pairs and thus an intermediate cryptocurrency such as stablecoins which are highly liquid and essential to overcome the ‘coincidence of wants’ that would otherwise heavily limit the liquidity of any order book or market maker.
Luna’s algorithmic stablecoin
The aforementioned USDT and USDC are stablecoins that are backed by actual assets. Circle claims to have their USDC stablecoin backed overwhelmingly by actual dollars, whereas Tether has been notoriously opaque regarding the contents of their USDT collateral, some speculate that less than 5% is actual dollars and that the rest is some form of commercial paper like T-bills, bonds, etc. TerraUSD is an algorithmic coin which by contrast had no collateral initially.
The peg is maintained to the dollar through a system of arbitrage whereby traders are financially rewarded for exploiting price discrepancies. On the Terra blockchain $1 of Luna can be burned to mint 1 UST and conversely, 1 UST can also be burned to mint $1’s worth of Luna. This swap is executed fully on-chain and hopefully protect with a hardware security module. The price of UST fluctuates on exchanges demand changes; when there is a lot of buying pressure on UST the price increases and, vice-versa, high selling pressure depreciates the price. Thus the on-chain swap can be leveraged to profit off of the price discrepancies on exchanges.
This system was supposed to keep the peg close to a dollar at all times. Algorithmic stablecoins have historically been very unreliable with many permanently losing their peg and losing investors millions in the process and soon we will see why Luna and its UST was no different.
Luna’s big bet on Bitcoin
In 2022, the Luna foundation secured funding to buy Bitcoin which would serve as collateral for its UST stablecoin. By April more than $3 billion had been purchased. The algorithmic stablecoin had not been collateralized prior and initially it was thought unnecessary, thus it seemed an odd choice. Perhaps the hope was that if Bitcoin would appreciate then the reserves would soon be heavily overcollateralized. But this gamble failed miserably.
This was because when the peg between UST and the dollar broke due to a sudden high volume selling of UST, the flood gates were opened as holders panicked after seeing their supposedly safe dollar pegged asset drop in value during the mass adoption of crypto. There was a veritable ‘run on the bank’ as retail and institutional investors sold their UST in order to move it into safer asset which further depreciated the dollar value of the UST. This forced the Luna foundation to sell their Bitcoin collateral in order to restore the peg, but unfortunately this large scale sale of Bitcoin caused its price to decline as well, resulting in a weaker backing than they had anticipated.
Once the dust had settled, the foundation had depleted all of its reserves but to no avail, as the UST peg remained broken and Luna lost over 99 percent of its value. Luna was also massively inflated as people exited from UST by burning it and minting Luna and then selling that Luna for whatever they could get for it. This hyperinflation contributed to the dilution of Luna’s value.
What does the future hold for Luna?
Luna appears to be beyond the point of no return. Those who tried to buy Luna after the crash just saw their money evaporate as the hyperinflation and selling pressure seemed to continue. Luna was also delisted from certain major exchanges to protect digital assets making Luna trading impossible on those sites. Do Kwon has announced that he will pursue efforts to rebuild Luna, but once trust is broken in such a severe manner in the financial world, it is near impossible to rebuild it. You can always follow the latest developments with our newsroom. A lot of people lost a lot of money because they decided to buy Luna or held on to UST. It will be very difficult for Do to get new investors. It should be said that Terra does have one of the most advanced developer sets in the COSMOS ecosystem and it would be a shame for it to go unutilized. Perhaps this tooling can be ported to a new project; that might be one to look out for.
Conclusion
This concludes our guide on the Luna cryptocurrency. We hope that if you still decide to buy Luna that you at least do so knowing the extreme risks, uncertainties and challenges associated with the project. Re-establishing trust in the Luna ecosystem seems a near impossible task as so many have been scarred from Luna trading. However, the crypto custody of your digital asset can be a certainty with Vaultavo’s innovative solutions such as fingerprint biometrics.
If you would like to learn more about the world of crypto and want to learn more about the importance of high quality crypto custody and storage be sure to check out our range of Vaultavo technology that is on offer.
Luna Trading FAQs
Is Luna a Scam?
We do not believe that Luna is a scam as that would imply that the team behind Luna intentionally drove their own token value down to zero, which is certainly against their own interest. It is much more likely that Luna is simply a failed project. It promised more than it could realistically deliver and had severe vulnerabilities that were identified and exploited by capital heavy adversarial forces. This is why it is so important to extensively research crypto projects before risking your money on them. It might not be a scam but we strongly advise you to not buy Luna or engage in Luna trading as it currently appears highly unlikely that the project will ever be able to regain its former glory as all trust is lost. If you decide to invest in digital assets, make sure your account is protected with fingerprint biometrics.
What are stablecoins that I can trust?
Stablecoins are essential for navigating the world of crypto, especially when you are investing or trading with a number of different cryptocurrencies. Now that UST, or TerraUSD, is no longer a viable option, let us highlight four alternative options: Tether (USDT), BinanceUSD (BUSD), CircleUSD (USDC) and DAI. Tether and Binance are less transparent with their collateralization process and Circle and DAI are generally considered safer and more trustworthy.
Should I still buy Luna?
We do not give financial and investment advice as a crypto custody service, but right now it would be extremely risky to buy Luna or to be Luna trading. All trust has been lost since Luna’s stablecoin broke its peg with the dollar. If you buy Luna now it would be akin to jumping onto a sinking ship. Luna trading is also very risky as exchanges may be forced to remove it from their platform. The price also seems to be on a continuous downward spiral and Luna trading might just instantly lose you money, be very cautious before you buy Luna.