Cryptocurrency market has been the cynosure or the eye candy for everyone for the past 2 years and this comes especially after the liquidity boost which was making everything seem so easy in the market and it seemed like there is no end to this hunky dory. As an investment advisor, I have peacefully listened to clients asking for investing in the crypto market and mind you, these are novice investors who don’t have the stomach for market volatility. Even a 5% decline would make them wary but the whole noise in the market about crypto germinated a FOMO around investors and behavioral biases never let you think in a straight line. This is what eventually happened to all the retail investors. This FOMO induced investing led people to invest their hard earned money in the cryptomarket.
What has been the eventual outcome – Dukh, Dard, Peedha (sadness, pain, despair)
Well, after this whole outburst of I TOLD YOU SO moment of me as an advisor, lets get to the question of Why is cryptocurrency crashing ?
Well in order to understand that you will have to understand some history of two currencies- UST(Terra) and LUNA. UST is a “stable Coin” (laughing in the background) whose value is being pegged with USD in such a way that one UST is equivalent to one USD. Luna is a sister currency of Terra or UST. Pegging is an economic mechanism via which the value of one UST shall be maintained equivalent to one US Dollar. UST via pegging was intending to maintain their value equivalent to one USD and hence were referred to as stable coin, it would be like a digital dollar. There were platforms like Anchor who were guaranteeing 20% interest rate on this digital dollar every year- sounds to good to be true right?
Stable currency whose deposits offered 20% ROI – are these god or what? Well you will see the demons soon. Just stay with me !
This is how the whole system used to work- It was important that the whole peg system is being maintained. So, UST should be equal to USD 1. For that to happen, USDT was being collaterailised by not any stable cash or cash reserve, but by using another currency called LUNA which is called the sister currency of UST. To peg a stablecoin like TerraUSD (UST), a USD value of LUNA is convertible at a 1:1 ratio with UST tokens. If UST’s price is, for example, at $0.98, arbitrageurs swap 1 UST for $1 of USD and make 2 cents. This mechanism increases UST demand and also reduces its supply as the UST is burned. The stablecoin then returns to its peg. Similarly, if UST is say 1.02$ then the abritarger would convert 1 UST value into dollar value of Luna and make an arbitrage profit of 0.02 cents. This is how the peg was maintained.
The system seems elegant on paper and a clever bit of financial engineering, but it is unproven. There have been multiple unsuccessful attempts in the past to create an algorithmic stablecoin. For instance, about a year ago a token backing up the stablecoin IRON, called TITAN, dropped to zero amidst market uncertainty in what the team called “the world’s first large-scale crypto bank run.” (Mind you, this was Mark Cuban Idea- one of the biggest Investor in the world)
It looks like Luna tried to learn from these failures, and concerns that some purchasers may worry about LUNA’s underlying value, so it also bought over $3 billion worth of Bitcoin and Avalanche as a further stabilizing mechanism for the protocol.
It is stipulated and speculated that Blackrock and Citadel asked for USDT from the founder of terra (terra Foundation) in return for bitcoin that they would sell them even at a discount. Founder of terra couldn’t see their plan and took the bait and this reduced the liquidity of Terra. Now the real problem started.Suppose the value of peg slipped to 0.98$, 1 USDT was equal to 1USD. In this situation we would ideally convert this into 1 dollar value and make some arbitrage profit. However, this time, when value fell, there was not enough USDT to swap and at the same time, blackrock took a short position in the market on USDT which created a short squeeze and the value of USDT just kept falling down while at the same time, BTC were also shorted so that UST founder office don’t have enough value of money to stabilize it and the whole system just came crashing down including the investors at anchor who were being offered 20% on USDT and they forced sell in a panic resulting in double whammy. Luna which at one time was trading at around 112$ in just 4 days has lost its major value and is perhaps less than 1 cents and we don’t see anytime its value would turn around.
TO put things in context, this means you invest 100 dollars in Luna, it goes up to become 11,200 dollars in two years and then it 4 days, it is almost equivalent to 0.
The above picture is of a YOutuber KSI who just lost his entire fortune perhaps in Luna.
So, what does this whole story foretell?
That the whole decentralization concept on which the blockchain and crypto was built is a facade, there is still a lot of centralisation of the currency and such manipulation can impact the market anytime soon and we might see more of such things coming. The currencies are still being held in large quantities by a few bigshots of the market who don’t have a care in the world to kill you. This crash is kind of equivalent to the 2008 financial crisis where the value of the market just eroded in days time and we are left with hot wind blowing to our face!!
Next time, when going for any digital currency- double check it yourself, don’t go by the words of any influencer like Tanmay Bhatt etc who would just sell you crypto wallets so that they can subside their EMIs.
This article is written by Nikhil Gupta, founder PoonjiMitra.
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Thanks it’s very useful