TerraUSD's (UST) and Luna's crash is perhaps one of the most unexpected events in the cryptocurrency market. While there was a lot of optimism about Luna's future and the ecosystem, the Terra venture still somehow nearly ended.
Seeing what happened, now may be an excellent time to reexamine any expectations you have about stablecoins. So here are four lessons to note from the collapse of UST and Luna.
Crashes are Almost Immediate
Being an algorithmic stablecoin, the UST is pegged to the value of a steadier asset, the greenback. However, that peg broke when the market was in a downtrend, pushing its value as low as 4 cents. And since the UST has a strong correlation with Luna, its sister token also lost around 90% of its value.
That slump occurred only in hours, and some investors could not have enough time to make their exit. That is why being alert and ready is crucial when you're faced with events such as this. One good move is to use stop-loss and take-profit orders on your open positions.
Stable Reserves are Vital
Stablecoins aims to provide the benefits of the cryptocurrency's speed and decentralization and the fiat currency's stability in value. However, the well-known stablecoins today don't follow a completely decentralized model.
Meanwhile, UST is an algorithmic stablecoin that uses an alternative model. Instead of dollars backing the token, the model made UST programmatically supported by the crypto Luna.
UST holders can always exchange their stablecoin for a dollar worth of newly minted Luna. Conversely, investors can redeem their Luna holdings for a UST equal to the dollar value of Luna redeemed.
That system resulted in arbitrage incentives like the USDT that regularly redirected the stablecoin's market price to one dollar.
However, UST's stability and liquidity were not as strong as the real dollar. If many UST holders were to exchange their holdings simultaneously, Luna's value could take a steep dive after exchanges were swamped with a great deal of supply. That, unfortunately, is what exactly happened this month.
The UST could have avoided such a situation if it was supported by an asset with a more robust market and less unstable value when pressured.
Major Crypto Players Can Still Fail
The UST's and Luna's crash supports that cryptocurrency assets remain highly risky. While cryptos like Bitcoin, Ethereum, and Cardano are already significantly valuable, they still carry a lot of risks.
Like other assets, cryptocurrencies are not entirely safe. Technical malfunctions, hacks, or conflicts can disrupt the crypto market. As a result, even major crypto players are at risk of experiencing sharp declines and losing their credibility.
Choose Value Over Hype
UST's and Luna's misfortune proves that several professional investors don't have much helpful information about what is safe and not in the cryptocurrency space.
The reliability of an investment is not based on its market value. While the majority is going where the money is, that doesn't mean you should do the same. Remember, using due diligence is crucial.
UST failed due to a flawed arbitrage mechanism that nearly everyone can analyze from the start. Previous coins that used similar mechanisms were tested and failed several years ago. That information, however, did not concern most investors.
So when they had the chance to leave before the collapse took place, many investors could not do their research and make the necessary preparations.