cryptocurrency Luna, which until a few days ago was among the ten most valued of the world, collapsed this week leaving thousands of investors stranded and causing a drag effect on the market.

In early May, a Moon it cost more than 80 dollars (It was worth 118 at the beginning of April). today its price does not reach the cent of dollar

the bitcoin dropped below $30,000, when less than a year ago it was worth almost double. The shares of Coinbase, the main cryptocurrency exchange house, plummeted and reached their historical low, according to data collected by El Periódico de España.

and all in matter of five days. The world of cryptocurrencies has experienced a tragic week.

It’s been a perfect storm“, says Fernando Gutiérrez, analyst and investor in crypto projects. “The rates are on the rise and inflation unleashed. Markets outside of crypto are also busted: most shares on the Nasdaq are down. And on top of all that, Luna’s collapse has made it worse.”

In other words, the external factors of the real economy —inflation, interest rates and business results— have been combined with those of the cryptocurrency market. Luna has crashed because its design, which relies on an algorithm to maintain stability, has failed..

On Reddit, a forum with a subforum dedicated to Luna, there are people saying that they invested their savings there by trusting the project. A user left a listing with telephones for the prevention of suicide from several countries, since there are testimonies of people who He has lost everything overnight.

“The panic was so strong that it dragged the rest down,” explains Diego Morín, an analyst at IG Spain. “Now there will be those who say that he is the end of cryptocurrencies. It won’t. But those pegged to a stablecoin [stablecoin] they can be attacked. The positive is that maybe accelerate a regulatory framework“.

the cursed algorithm

The value of most cryptocurrencies —bitcoin among them— is marked by supply and demand: As in other unregulated assets, the price rises when demand increases (more people buying) and falls when supply increases (more people selling).

that makes them extremely volatilethat their price fluctuates so frequently that even a tweet from Elon Musk sinks or shoots them because people react.

But Luna’s operation was different. This crypto was linked to a stable currency (called UST) in order to avoid such volatility.

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Stable currencies, or stablecoins, are cryptocurrencies whose value is in turn linked to that of a legal tender currency; in this case, the dollar. The idea is that a unit of stablecoin is always worth one dollar.

In the case at hand, Luna is the cryptocurrency and UST its stablecoin. And, until the catastrophe happened, the goal was that UST = 1 dollar.

To maintain equivalence with the dollar, other stablecoins hold reserves of real money in cash. But UST doesn’t do it that way. The equivalence with the dollar is achieved automatically, through an algorithm that creates and destroys Luna cryptocurrencies to try to maintain it.

Investors are interested in this system because if the equivalence deviates (if the UST falls below one dollar) they can make money by buying or selling Luna to balance it out.

And so it was until the equivalence ‘cracked’ and broke:

Gutiérrez has a thread on Twitter explaining the factors that have caused the breakdown of the mechanism, which ultimately boils down to loss of investor confidence (they sell UST, the price of Luna falls and the equivalence with the dollar is broken). There are also people in the crypto community who believe that it has been a coordinated attack.

“It is known that the sales of UST came from a single actor. I don’t know if it was coordinated, but it is certainly intentional,” says Gutiérrez.

As if that were not enough, the creators of UST/Luna recently introduced changes to the system, buying bitcoin to use as a reserve in case the equivalence (the one that the algorithm is supposed to safeguard) deviates. Those changes weren’t quite finished: they were a few weeks away from completion.

When it broke, and since the algorithm could not correct such a large volume of sales, they resorted to these reserves: they sold bitcoin ‘manually’ to buy UST and try to save its value. But that didn’t work and compounded bitcoin’s decline, which in turn compounded everything else’s decline by creating “a vicious circle that drags everythingGutierrez says.

“It is not clear how much bitcoin they came to sell or at what price,” adds the expert. “This defense with bitcoin aggravates the market situation“.

Even so, it continues, relatively speaking this ‘cryptocrash’ has been less than that of 2014, when Mt. Gox, one of the most popular cryptocurrency exchanges in the world, collapsed. Investors lost 5% of what the market was then worth. Now, the loss has ‘only’ amounted to 2%.

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“Everything is up in the air”

The United States Department of the Treasury drew attention months ago to stablecoins and asked Congress for a law that requires their issuers to meet the same requirements as normal banks.

After the collapse of Luna and the drag it has caused, the Secretary of the Treasury urged speed up this regulation.

“Over the past few days we have seen a real-life demonstration of the risks of stablecoins, which are the same as we have seen for centuries in times of crisis. bank run“, he said, in statements collected by The New York Times.

“The theory of cryptocurrencies is ‘hold’ [aguantarlas, no vender en momentos de pánico]. That has its risk. As there is panic and people saying that bitcoin is going to drop to 20,000 euros, there is who gets rid of them so as not to lose all his capital and the price drops even more“, says Morín, the IG analyst.

According to Morín, the current situation will speed up regulation. “We won’t know the whole truth about what happened, but I think this marks a before and after. We’ll see if cryptocurrencies recover,” he says. “But it’s also that everything is like mud. The current context is complicated and the market fears a recession“.

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The fall of Luna, adds Gutiérrez, affects Bitcoin and other cryptocurrencies as long as there are “a loss of confidence in general. There is fear that the collapse will drag down others.” Tether, the world’s largest stablecoin, also fell below the dollar this week as investor panic spread. This analyst believes that, although there may be more falls, cryptocurrencies “will survive as they always do”.

Meanwhile, Terra’s creator—a Korean named Do Kwon—has proposed a series of changes to rebuild the coin and has vowed to “keep making noise.” The rest of the cryptocurrencies recovered slightly on Friday, although bitcoin It remains below 30,000 euros and marks minimums since 2020.

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