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Breaking: Why Did Terra (LUNA) Crater 95% Today? Should You Buy?

The Ascent logo The Ascent 5/11/2022 Tor Constantino
A tired man rubbing his eyes and sitting at his desk at work. © Getty Images A tired man rubbing his eyes and sitting at his desk at work.

While traders on cryptocurrency exchanges are used to volatility, today's price action surrounding Terra (LUNA) has been breathtaking -- in the worst way possible. Over the past 24-hour period, LUNA fell from $24.98 per coin at 4:04 p.m. EST time yesterday to $1.25 at time of writing, marking a 95% price plunge according to CoinMarketCap.com.

What happened to Terra (LUNA)?

A little context is needed to understand LUNA's crypto crash. First, LUNA is the primary asset used to regulate and maintain the value of its complementary, algorithmic stablecoin TerraUSD (UST). It's also critically important to know that LUNA, UST, and the Luna Foundation Guard are all crypto creations of Terraform Labs and its CEO/Co-founder, Do Kwon.

Now, traditional stablecoins have direct 1:1 backing of hard assets such as fiat currency, gold, bonds, or commodities. An algorithmic stablecoin -- such as TerraUSD (UST) -- relies on sophisticated software to adjust the circulating supply of the stablecoin to automatically adjust the price to match the asset it wants to mirror, which is the U.S. dollar for UST programmers.

However, for the UST to maintain its aspirational 1:1 peg to the U.S. dollar -- without actually holding any U.S. dollars on deposit -- the UST software automatically adjusts the price of its sister crypto coin LUNA, so that $1 of LUNA matches $1 UST, thereby matching the U.S. dollar. This algorithmic price shifting creates arbitrage opportunities for savvy investors to trade between LUNA and UST at lower prices on one exchange, for higher prices on other exchanges to help to restore market equilibrium for both coins.

To provide additional confidence to investors, the Luna Foundation Guard bought more than $3.5 billion worth of Bitcoin over the past few weeks to use as liquidity to inject into the market it needed.

Despite all this financial engineering, TerraUSD (UST) started to slip in value to the U.S. dollar late last week due to fears over rising inflation and the Fed's raising of interest rates. That triggered a sell off by Terraform Labs of both LUNA and Bitcoin earlier in this week to try and restore the UST peg to the equivalent value of $1.

It worked for a bit but the UST stablecoin fell today to as low as $0.29 at 3:45 a.m. EST, completely decoupled from the U.S. dollar peg this morning and dragged LUNA down with it. The UST stablecoin has rebounded to $0.68 at the time of writing according to CoinMarketCap, but it's still 30% off its target peg price.

Terraform Labs CEO announced a plan to fix this

Earlier today, Terraform Labs CEO Do Kwon, shared a 14-part tweet to his more than 533,000 Twitter followers outlining the most urgent need, empathy for Terra investors, as well as an initial proposal to resolve this crisis by pumping massive amounts of crypto assets into the market.

"Before anything else, the only path forward will be to absorb the stablecoin supply that wants to exit before $UST can start to repeg. There is no way around it. With the current on-chain spread, peg pressure, and UST burn rate, the supply overhang of UST (i.e., bad debt) should continue to decrease until parity is reached and spreads begin healing. Naturally, this is at a high cost to UST and LUNA holders, but we will continue to explore various options to bring in more exogenous capital to the ecosystem & reduce supply overhang on UST," Kwon stated in his tweet series.

Kwon also stated that he's seeking additional funding from investors to serve as collateral to ensure the solvency of the project going forward.

Should you buy Terra (LUNA)?

It's important for every person to do their own investment research and only use an amount that you're comfortable losing. While not investment advice, even though LUNA is priced at a remarkable 98.9% discount from its all-time high set on April 5, there is too much uncertainty surrounding the entire Terra ecosystem for new entrants to join.

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We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Tor Constantino has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin and Terra. The Motley Fool has a disclosure policy.

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