Is Terra (LUNA) on the Verge of Collapsing?

Terra's UST stablecoin fell way off its peg, sparking an over 40% decline in LUNA -- is the party over?

What Is Terra (LUNA)?

Terra is a blockchain protocol that uses fiat-pegged stablecoins to power price-stable global payments systems. According to its white paper, Terra combines the price stability and wide adoption of fiat currencies with the censorship-resistance of Bitcoin (BTC) and offers fast and affordable settlements.

Development on Terra began in January 2018, and its mainnet officially launched in April 2019. As of September 2021, it offers stablecoins pegged to the U.S. dollar, South Korean won, Mongolian tugrik and the International Monetary Fund's Special Drawing Rights basket of currencies — and it intends to roll out additional options.

Terra's native token, LUNA, is used to stabilize the price of the protocol's stablecoins. LUNA holders are also able to submit and vote on governance proposals, giving it the functionality of a governance token.

Who Are the Founders of Terra?

Terra was founded in January 2018 by Daniel Shin and Do Kwon. The two conceived of the project as a way to drive the rapid adoption of blockchain technology and cryptocurrency through a focus on price stability and usability. Kwon took on the position of CEO of Terraform Labs, the company behind Terra.

Prior to developing Terra, Shin co-founded and headed Ticket Monster, otherwise known as TMON — a major South Korean e-commerce platform. He later co-founded Fast Track Asia, a startup incubator working with entrepreneurs to build fully functional companies.

Kwon previously founded and served as CEO of Anyfi, a startup providing decentralized wireless mesh networking solutions. He has also worked as a software engineer for Microsoft and Apple.

What Makes Terra Unique?

Terra seeks to set itself apart through its use of fiat-pegged stablecoins, stating that it combines the borderless benefits of cryptocurrencies with the day-to-day price stability of fiat currencies. It keeps its one-to-one peg through an algorithm that automatically adjusts stablecoin supply based on its demand. It does so by incentivizing LUNA holders to swap LUNA and stablecoins at profitable exchange rates, as needed, to either expand or contract the stablecoin supply to match demand.

Terra has established a number of partnerships with payments platforms, particularly in the Asia-Pacific region. In July 2019, Terra announced a partnership with Chai, a South Korea-based mobile payments application, in which purchases made using the application on e-commerce platforms are processed via the Terra blockchain network. Each transaction is subject to (on average) a 2%–3% fee charged to the merchant.

In addition, Terra is supported by the Terra Alliance, a group of businesses and platforms advocating for the adoption of Terra. In February 2019, the company announced that e-commerce platforms from 10 different countries, representing a user base of 45 million and a gross merchandise value of $25 billion, were members of the alliance.

What happened

Most investors have seen just how brutal the cryptocurrency market has been of late. However, for investors in algorithmic stablecoin Terra (LUNA -48.33%), it's been quasi apocalyptic of late.

As of 9 a.m. ET today, Terra has plunged 43.6% over the past 24 hours. This comes as Terra's stablecoin, TerraUSD (UST -8.15%), sunk to the $0.93 level, representing a 7% fall from its peg over the past 24 hours.

At the time of writing, Terra has fallen below the $35 level for the first time in six months, sparking what could be one of the most impressive sell-offs among large-cap tokens we've seen this year. This rapid decline has pushed LUNA out of the top 10 list of tokens by market capitalization, with LUNA's market cap now below $12.5 billion.

So what

For investors who may not be aware of Terra's model as an algorithmic stablecoin, LUNA tokens act as the reserve currency supporting the network's UST token. Besides some Bitcoin and other digital assets backing this stablecoin, Terra maintains its peg by minting and burning its native token, LUNA. In other words, the stability of UST depends a great deal on the stability of LUNA.

However, with a rapid decline in the price of LUNA, UST has fallen off its peg. While UST has clawed back much of its losses, now around $0.93 per token, it previously fell as low as $0.6841, signaling some serious trouble and concerns about a potential collapse for this key stablecoin.

The stablecoin market is very important to the proper functioning of many aspects of the crypto market. If investors lose faith in the underlying value of stablecoins, the potential for market contagion to take hold is real. Thus, many investors are watching how Terra's LUNA and UST tokens perform in this volatile environment.

Now what

Moving forward, there's increased uncertainty with respect to how the market will regain its trust in UST and other stablecoins amid this impressive sell-off. Many investors expected some sort of test for UST and other algorithmic stablecoins due to the recent volatility in the markets. However, the market consensus for how Terra was able to navigate this bout of volatility is increasingly deteriorating.

It's worth noting that UST has lost its peg in the past and regained it. However, this dramatic dip in the price of UST may shake the faith of investors in Terra for some time. How much damage is permanent versus temporary remains to be seen. However, until UST regains its peg again, these discussions are likely to continue.

Terra's Luna Foundation Guard has announced that it would loan $750 million of Bitcoin to over-the-counter firms to help protect the UST peg, as well as loan $750 million UST to buy Bitcoin in its stabilization efforts. These moves appear to be pushing UST higher and could potentially work. However, these remain tenuous times for investors considering Terra.

Personally, I think how Terra's founder Do Kwon and the Luna Foundation Guard manage this crisis will determine how this token will perform long term. This could perhaps be the most important 24 hours of Terra's existence to date. Investors will want to keep a close eye on how UST performs in the hours and days to come -- it could be a bumpy ride.