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The Collapse of LUNA: What Happened and Why?

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The Collapse of LUNA: What Happened and Why?

Terra blockchain’s stablecoin UST lost the peg this week, crashed and brought the whole cryptocurrency market into a catastrophe long unseen.

Billions were wiped out of the digital asset market during the past 24 hours, while Terra’s native governance coin LUNA lost 99% of its value and nosedived from $24.14 to $0.1538 over the same time period.

What happened?

To better understand the collapse of LUNA, it is important to know its relation with blockchain’s stablecoin TerraUSD (UST). Both coins are created and guided by Terraform Labs and its co-founder and CEO Do Kwon.

TerraUSD (UST) is a decentralized algorithmic stablecoin, pegged 1:1 with the United States dollar. However, it is not backed by the dollar or any other fiat currency or commodity. Instead, UST relies on a smart contract algorithm that involves LUNA and helps to keep the UST value stable.

The algorithm tracks the demand for the TerraUSD (UST) and adjusts its supply accordingly to keep the value around $1. If the supply increases and the value of UST drops, the algorithm incentivizes users to burn UST to mint new LUNA coins and vice versa.

Do Kwon and his Luna Foundation Guard declared plans to back their algorithmic stablecoins with Bitcoin and thus have been accumulating their Bitcoin holding intensely. During the past few weeks, LFG bought over $3.5 billion worth of the dominant crypto. The situation drastically changed on Sunday, May 8. The stablecoin UST started to go down in cascades, losing 70% of its value and dropping to an all-time low of $0.029 on Wednesday.

To keep the price of UST as stable as possible, Terra’s algorithm initiated UST token burnings in exchange for the newly minted LUNA coins. The supply shock triggered the LUNA price fall, and the panic sales did the rest.

Where did it all start?

However, for any more visible price move to happen, there must be an initial source that triggers it.

Rumors on crypto social media went wild, claiming that the world’s biggest asset manager BlackRock (NYSE:BLK) as well as Citadel Securities could be behind the collapse of TerraUSD and LUNA.

Supposedly both whales manipulated the market and Terra’s Do Kwon to dump the price of Bitcoin.

As the theory says, they first borrowed 100K of BTC from Gemini and silently swapped 25% of them to UST. Later agreed with Do Know to sell him another part of borrowed Bitcoins for UST, at a discounted price. Do Kwon agreed, resulting in a significant decrease in the UST supply.

Following the algorithm, this should have affected both coins, as when UST supply decreases, the price increases, and to maintain UST price stability, smart contracts burn TerraUSD stablecoins to mine more LUNA tokens, which automatically increases its supply and reduces the price.

However, at a time, both hedge funds supposedly made another move. They dumped their UST and Bitcoins, triggering the further price crash of Bitcoin and also LUNA.

A large part of LUNA’s reserve was at a time kept on Anchor lending and borrowing protocol blamed to be Pozi scheme with 20% staking APY. According to theory, BlackRock and Citadel knew the fact, that LUNA’s price crash would cause massive withdrawals from Anchor, panic selloffs, and thus further price drops.

As the broader market crash means the lower price of Bitcoin, both whales would be free to buy Bitcoins back for a cheaper price, repay the loan and make some profit.

Both BlackRock and Citadel denied accusations of having a role in the collapse of UST calling them “categorically false”. BlackRock stated that it does not trade UST. The world’s largest asset manager though has been exploring cryptos over the past year and has backed TerraUSD’s competitor USDC.

The Aftermath

The crypto landscape looked grim today, with more and more new worries emerging. Multiple DeFi projects that had liquidity pools with LUNA and UST, including Anchor Protocol (ANC) and Mars Protocol (MARS), witnessed a double-digit declines.

The competing stablecoin Tether (USDT) briefly lost its 1:1 peg with the US dollar and dipped by 4% to $0.9508 today, reaching the lowest level during the past few years. Tether CTO Paolo Ardoino explained that Tether was continuing USDT redemptions to $1 and more than 300 million were redeemed in the past 24 hours without any price drop.

The founder of TRON, Justin Sun warned that Tron (TRX) and its algorithmic stablecoin USDD might become the next manipulators’ target, as the latter uses the same algorithmic mechanism to maintain the USDD stability.

Cryptocurrency

Price analysis 5/16: BTC, ETH, BNB, XRP, ADA, SOL, DOGE, DOT, AVAX, SHIB

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Price analysis 5/16: BTC, ETH, BNB, XRP, ADA, SOL, DOGE, DOT, AVAX, SHIB

The selling in Bitcoin (BTC) is showing no sign of abating and Bitcoin has fallen for seven straight weeks for the first time ever. This indicates that the momentum remains strongly in favor of the bears.

While the short-term sentiment remains bearish, institutional traders seem to be taking a longer-term approach on cryptocurrencies. Goldman Sachs (NYSE:GS) and Barclays (LON:BARC) joined several other institutional investors in a $70 million Series A funding round by institutional trading platform Elwood Technologies.

Daily cryptocurrency market performance. Source: Coin360

BTC/USDT daily chart. Source: TradingView
ETH/USDT daily chart. Source: TradingView
BNB/USDT daily chart. Source: TradingView
XRP/USDT daily chart. Source: TradingView
ADA/USDT daily chart. Source: TradingView
SOL/USDT daily chart. Source: TradingView
DOGE/USDT daily chart. Source: TradingView
DOT/USDT daily chart. Source: TradingView
AVAX/USDT daily chart. Source: TradingView
SHIB/USDT daily chart. Source: TradingView

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Cryptocurrency

Top 5 cryptocurrencies to watch this week: BTC, MANA, MKR, ZEC, KCS

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Top 5 cryptocurrencies to watch this week: BTC, MANA, MKR, ZEC, KCS

Bitcoin (BTC) has been relatively calm during the weekend as crypto traders try to rebuild the markets after the Terra LUNA debacle. With macro factors not supportive, several analysts expect the recovery to be a slow grind.

Crypto research firm Delphi Digital said in a recent report that the rally in the United States dollar index (DXY) had pushed its 14-month relative strength index “above 70 for the first time since its late 2014 to 2016 run up.”

Crypto market data daily view. Source: Coin360
BTC/USDT daily chart. Source: TradingView
BTC/USDT 4-hour chart. Source: TradingView
MANA/USDT daily chart. Source: TradingView
MANA/USDT 4-hour chart. Source: TradingView
MKR/USDT daily chart. Source: TradingView
MKR/USDT 4-hour chart. Source: TradingView
ZEC/USDT daily chart. Source: TradingView
ZEC/USDT 4-hour chart. Source: TradingView
KCS/USDT daily chart. Source: TradingView
KCS/USDT 4-hour chart. Source: TradingView

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Cryptocurrency

Crypto capital gains one of four key areas for Australian Tax Office

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Crypto capital gains one of four key areas for Australian Tax Office

The Australian Taxation Office (ATO) has outlined crypto capital gains as one of four key areas of focus in 2022.

A capital gain or loss refers to the price difference between the time an asset was purchased and the time it was sold. The percentage owed to the ATO varies between income brackets and duration of ownership, but in general, the rate is reduced for assets held longer than 12 months.

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