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Cryptocurrency investors are reeling and wondering what comes next after a massive market shakeup sent the price of bitcoin plummeting to its lowest level in 17 months last week.
The pullback was triggered by the collapse of two of the largest cryptocurrencies — the stablecoin terraUSD (UST) and its sister token luna.
Terra’s value is meant to stay at $1. But it wasn’t backed by real-world assets. Instead, the two tokens were tied in value to one another like a seesaw. One token would be automatically created or destroyed based on the supply and demand of the other.
But why did investors sink so much money into these tokens?
A scheme known as the Anchor protocol promised crypto investors annual returns of nearly 20% in exchange for lending out their terra holdings. With cryptocurrency markets relatively stagnant since December, the lure of 20% returns seemed too good to pass up.
But few terra/luna investors paused to realize they were stacking risk on top of risk on top of more risk.
New York Magazine described the system “as a perpetual wealth-creation machine, a way to always make money through the magic of code and financial engineering.”
The machine worked great — until it didn’t.
Terra’s algorithm eventually broke — there’s still some confusion and debate over why — and its value started nosediving May 8. As investors sold off UST, the supply of luna ballooned, causing its price to plummet. From there, UST and luna locked arms in a death spiral race to the bottom.
By May 12, the stablecoin once pegged at $1 was trading for less than a penny.
The collapse of terra and luna erased some $45 billion in market capitalization in a week. Experts say that money is unlikely to return. The fallout sent ripples across the entire crypto ecosystem, causing bitcoin and ethereum to hit lows not seen since December 2020.
By May 16, bitcoin traded at around $29,000 — more than a 50% decline in value from its all-time high of…
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