Elaine Jean Tech 05.21.2022 02:May AM EDT

Cryptocurrency Crash Course: Terra, LUNA, and UST, What Are They and What’s Happening?

The cryptocurrency industry is taking a massive swing from Terra's blockchain, both Terra (LUNA) and TerraUSD (UST).

It has experienced an extreme amount of volatility for the past few days. Crypto is now again in the limelight as all eyes focus on how it is going to move next.

News like Bitcoin is at its lowest, investors losing big on Bitcoin, stablecoins losing their dollar peg, Terra coins plummeting, and much more like that have been all over the internet for the past few days. Indeed, May has given a rough tide to the crypto sector.

To keep you in the loop, here's what happened to the Terra blockchain, LUNA, and UST.

What Are Terra, LUNA, and UST?

The Terra blockchain carries two coins under its system: the Terra (LUNA) and TerraUSD (UST). The Terra blockchain produces LUNA, just like how the Ethereum blockchain produces its own native coin called Ether.

On May 1, the price of Terra (LUNA) was at $80.7. However, the price of Terra (LUNA) today is at $0.0001402 due to the depreciation of value.

The TerraUSD, also known as UST, is a stable coin. To be specific, it is a digital algorithmically stabilized coin. Burning LUNA is required in order to produce UST. The LUNA would have been burned in the process of making the exchange.

As stated by CoinDesk, "this involves using a smart contract-based algorithm to keep the price of TerraUSD (UST) anchored to $1 by burning (permanently destroying) LUNA tokens in order to mint (create) new UST tokens."

The goal of this deflationary protocol is to ensure the continued expansion of the coin over the long term. As more people buy into UST, a greater quantity of LUNA will be burned, which will cause the remaining quantity of LUNA to increase in value.

What is a stablecoin?

In its most basic form, it is a form of cryptocurrency that is linked to another, more reliable currency. Stablecoins are an essential component of DeFi, which stands for decentralized finance. These kinds of coins play a huge role as they usually cushion the price swings and volatility in the crypto market.

According to CNET, Tether and USD Coin, two of the most prominent examples of this type of cryptocurrency, are both pegged to the value of the US dollar. This means that investors with 1,000 USDC tokens can exchange them for a real cash amount of $1,000. In the event of market swings and volatility, 1 stable coin should always be equal to $1... back then.

However, Terra's stable coin, UST, is not backed by actual US dollars like tether and USDC are. But rather, it is what is known as an algorithmic or decentralized stablecoin. Instead of US dollars backing Terra's UST, it is backed through the use of billions of bitcoins in reserve.

How Did Things Get Bad?

The depegging of terraUSD (UST), a stablecoin that was always designed to have a value of $1 despite market fluctuations, was the root cause of the token's decline.

As previously reported in iTechPost, it all began with the company's Anchor Protocol on May 7. The Anchor Protocol enticed investors and traders to save their coins on its platform by providing lucrative incentives. The announcement was spread immediately, and users were quick enough to seize the opportunity and move their operations to Anchor.

However, during this time, the Federal Reserve has indicated that it will hike interest rates. As a result, users swiftly began withdrawing their currencies in large quantities, leaving Anchor all at once.

There are rumors and unverified news stating that there is so much more to this. It is unclear whether this was a response to an extremely volatile market, the news of the Federal Reserve, or a malicious breach of Terra's system.

Approximately two billion dollars' worth of UST was removed from the Anchor Protocol, and immediately afterward, hundreds of millions of dollars worth of UST was sold. Because of the crypto volatility at the time, there was a massive selling frenzy, with millions of traders selling their 91-cent UST for 1 LUNA in an attempt to profit.

However, things got ugly. In Terra's system, there is only $100 million worth of UST that can be burned for LUNA on a daily basis. The moment that Terra's UST, a stablecoin that is supposed to remain at $1, began to go down, traders immediately sold all of their UST holdings.

The TerraUSD price on May 1 was at $1, maintaining its value. However, after all, that has happened, TerraUSD's price now is at $0.0789409, as per Binance. Terra had a market cap of $18 billion at the beginning of May, but as of writing, it now only has $890.37M.