Crypto is known to be a highly volatile asset class, but the recent LUNA crash came as a shock to novice and seasoned investors alike. What happened to LUNA, and what happens next?

The native staking token of the Terra Ecosystem, LUNA absorbs the price volatility of UST (TerraUSD), a stablecoin built on the Terra blockchain.

You may want to find out more about stablecoins.

Terra users can stake LUNA to validators – in other words, Terra blockchain miners – who, in turn, record and verify transactions on Terra and are rewarded from transaction fees.

It is worth mentioning that validators are an integral part of the Terra blockchain as they ensure its accuracy, security, and decentralization.

UST is an algorithmic stablecoin. If you are struggling to understand what “algorithmic stablecoin” means, here is an explanation: it uses a procedure where LUNA is burned as UST is minted, and as UST is burned, LUNA is minted to retain the 1:1 USD peg. It is this ebb and flow that fell apart in the recent event.

The cost of UST fell as a result of what is believed to have been caused by organized manipulation to put pressure on the algorithm by swapping extremely large sums of UST for other stablecoins on the “Curve Pool”, which acted like an accumulator for UST. This caused general negativism in the market: Terra failed to maintain a balanced system and a healthy market. As panic set in and as the community wanted to cash in their UST in a short period of time, commonly known as a “bank run”, the situation became worse, resulting in what is known as a “death spiral”.

To explain further, when the dollar value fell from US$1 to US$0.68, investors chose to either liquidate their UST into other stablecoins, or risk further loss in value. This further exacerbated the problem.

When UST began to drop below $1, LUNA, per the mechanism, was minted in order to maintain the peg, utilizing the method of minting LUNA when UST is burned to ensure that the UST:LUNA liquidity pool remains balanced. Both the UST side and the LUNA side have the same dollar value. Neither the algorithm of the Terra Protocol nor the selling of BTC out of Luna Foundation Guard (LFG) reserves to trading firms – hoping to collateralize the token – could bring UST back to $1.

As a rather devastating result, UST plunged to less than 15 cents, while LUNA became worthless due to the extreme quantity issued to the market.

Following the crash, Do Kwon, CEO of TerraLabs, announced a plan to revive LUNA – by forking the old Terra blockchain into a new one. Luna token holders were allowed to vote on the proposal, with the majority of token owners voting in favor of Kwon’s plan. The TerraUSD stablecoin was voted out, having plunged beyond its intended peg to the US dollar, and having realized the algorithmic method had failed without equal collateralization.

The new Terra blockchain, or Terra 2.0, became the default Terra blockchain, ‘mainnet’, with a new LUNA crypto, whereas the original Terra blockchain and the LUNA token were renamed to “Classic” and “LUNA Classic (LUNC)” respectively. 

A new version of LUNA is already available for trading on major exchanges. Investors that held either UST or LUNA before, and after, the crash were airdropped LUNA 2.0 with varying levels of distribution – as a way to make up for some of their losses, and retain community members within the protocol.

Please read Coinmetro’s LUNA 2.0 Distribution Statement.

The viability of Terra 2.0 is yet to be determined. With TerraUSD no longer being part of the game, another total collapse is less likely to happen. LUNA now represents the protocol not dissimilar to SOL, KDA, FTM, AVAX, etc., and is no longer a mechanism tied to UST.

Although trust is lost in many cases, the Terra community does maintain a strong following as well as does have support of hundreds of developers and strong VC backing. Yet the best way to manage your risks and minimize your losses is by diversifying your portfolio.

If you find it hard to stay up to date with the latest crypto news, we encourage you to join Coinmetro’s Discord or Telegram communities to keep up with the latest developments. Alternatively, you can sign up to our platform in just a few steps to start trading crypto today.