On one regular day in May 2022, Terra took a bungee jump off the crypto cliff and never quite made it back up, leaving many to bemoan their losses or scramble to recoup them.
In case you aren’t as knee-deep in crypto drama as some of us, I’m going to do a brief insight into what Terra was all about before the nosedive. Terra was a DeFi ecosystem steamrolled by two coins, namely: TerraUSD (UST) and Terra (LUNA). The former was a stablecoin while the latter was a token for utility and governance.
Before any asset can be pegged to another asset like USD or Tether, it must first have the equivalent of its value deposited as its reserve. However, for Terra, the reverse was the case. Instead of pegging their asset, Terra chose not to have gold reserves like the average central bank in traditional banking systems; they formed a stablecoin that worked with the market algorithm.
The job of this algorithm was to monitor the demand for UST. High demand meant more UST was to be churned while a decline meant that UST was to be burned. Using this was supposed to keep a set balance of 1 UST TO 1 USD (fiat).
The result of all of this was that every UST created meant a dollar worth of LUNA being burned and vice versa. This also meant that UST was the reserve for LUNA.
You are probably wondering how they really kept the price at the one-dollar mark and here’s how they did it. With the price of UST pushing past $1, arbitrage users could sell-off thus causing the price to drop.
Another thing they would also do was to buy at a discount when the price dropped lower than $1, and then swap for LUNA. While this was a smart move to maintain a currency with low volatility without costly fiat reserves, it didn’t stop LUNA from taking a hit.
At 2 pm CET On May 9, 2022, UST dropped and kept dropping in the five hours that followed. The plunge from $0.94 to $0.93 didn’t bother most people. Until the price started to sink! No one knows who is responsible for this malicious strike and fingers seem to point at hedge funds Blackrock and Citadel who of course, denied having anything to do with it.
Ava Lab’s John Wu, took to social media to state that
“Kwon is a visionary genius, but his hubris killed Terra.”
In a Reddit post, one user bemoans his loss of more than 450k USD and that's just one user who went all in.
I can’t imagine how painful it is for a lot of folks at the moment and don’t get me started on the fear this incident alone is spreading of the bear market in the crypto space.
However, there are a couple of lessons to be learned from Terra’s recent crash.
- DON’T IGNORE MACROECONOMIC TRENDS
You can’t have a crypto market without real-world events. And these events shape how the market moves most often than not.
The recent ones are the COVID-19 pandemic, increase in energy prices, the Ukrainian crisis, and shortage of supply chains, and the impact has been prominent; pointing to inflation and most likely imminent recession.
In this case, placing your bets against a recession is more dangerous than putting your funds in a bull market.
- DON’T SWALLOW THE FOMO BAIT
When you’ve got every Tom, Dick, and Harry tweeting and texting about a project, it can be hard to ignore the temptation to get your fingers in the pie too. For Terra, there was so much hype around it the project practically seemed invincible.
But the hype is not enough reason to invest in a project. There’s something called DYOR which means Do Your Research.
And this is one of the basic principles of investing. Don’t invest in something you don’t understand or have adequate information on. Greedy, bullish crowds will try to tell you where to put your money by boasting about a project that will “hit the moon” soon.
- ALGORITHMS LIE SOMETIMES
The crash of Terra Luna is enough proof of how wrong the algorithms can be sometimes. This calls for caution when dealing with algorithmic coins.
The best you can do is find out how scalable that coin is and how expansively its technology has been verified.
- SPREAD YOUR PORTFOLIO
Everyone knows that the folks who were most hurt by the Terra crash were the ones who put most of their investments into the project. Not a very smart move if you ask any sound investor.
You’ve got to be ready for the worst. Hence, the need to diversify your portfolio so you don’t lose everything. The trick here is not avoiding risky projects altogether, it’s properly assessing the risks before going all in.
Also, your portfolio should not majorly comprise risky assets. The crypto space in itself is quite volatile. You don’t want to set yourself up for failure from the onset.
- DECENTRALIZATION IS NOT EASY BUT NOT IMPOSSIBLE
Besides the regular hype surrounding Terra, developers made a lot of noise about building a currency that is decentralized for a decentralized economy.
When it came down to it, we discovered a dense governance structure and high centralization behind the façade. Governance was revealed to be shuffled between Terraform Labs, Luna Foundation Guard, and Do Kwon with users having little or no stake in many of the hurried moves made by the ‘inner circle’ during Terra’s last moments.
As if that wasn’t enough, Terraform Labs moved in the shadows to freeze Terra’s blockchain without consent from the community. Pretty shady for a platform, one of whose goal is to prevent governance attacks.
As slippery as decentralization in the blockchain can be, it’s possible if a project’s developers are truly committed to keeping it decentralized.
If a project that lays claim to decentralization turns out to be the opposite, it never wanted to.
- ALWAYS APPLY THE K.I.S.S PRINCIPLE (Keep It Simple Stupid)
The KISS principle has always been a personal favorite of mine and I like to believe Terra’s Do Kwon had people telling him this a lot. In every sphere of life, there remains a need to stay humble even when you are swimming in dough.
Watching Terra crumble after shows of brazen confidence and rudeness is a tad amusing and a big lesson to learn from in the industry.
The co-founder of Terra was notorious for his condescension to both critics and competitors and is, unfortunately, paying for his hubris with lawsuits and fines running into millions.
In the November bull market, Do Kwon referred to a tweet describing the fall of Terra courtesy of an attack as “the most retarded thread” he had read.
Do Kwon also called the tweet stupid and openly invited whales to try this attack. We see how all of this braggadocio ended later on, so much so that a lot of folks are hesitant to support is hard fork alternative.
In the crypto scene today, all it takes is a few tweets and you find yourself at the bottom of the barre. So get rich but stay humble.
- AVOID STABLE ASSETS WITHOUT STABLE RESERVES
With stablecoins, you get the best of both worlds: the stable value of fiat and the speed and decentralization of crypto. Tether supports USDT with stable reserve assets that are very liquid and non-decentralized.
These reserves are audited regularly by private companies to be sure they are truly convertible and collateralized. TerraUSD, on the other hand, was backed by LUNA, a crypto gem instead of fiat currency.
Hence, it’s the inability to withstand the attack due to LUNA not having the same liquidity or stability as real dollars.
Conclusion
Don’t learn later, learn NOW! We love cryptocurrency, but it’s a hornet’s nest of hacks, wild FOMO culture, zero regulation and transparency, thefts, financial innovation, and anonymity.
A lot of the investors and developers you assume to know what they are doing or have everything under control sometimes don’t.
The failure of Terra should be an adequate incentive for every crypto enthusiast to go back to the books and properly understand their crypto investments before going all in.
Nobody can do that for you. And that’s the same way nobody will come running to save you when your investments crash. Play safe. Play smart!
