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Terra Luna

Terra Luna´s Hyperinflation


Thomas - 18 May 2022 - 15 min read

Welcome to digital hyperinflation: welcome to Terra (Luna) and UST.

Last week, the cryptocurrency Terra (Luna), till then the sixth largest coin after Bitcoin, Ethereum and BNB, lost about $20 billion in value. More or less at the same time, the “stable” coin UST (also called “TerraUSD”) has dropped in value by about $15 billion. If Coinformation were the press, we would write “the money was burned“.

Anyway, on May 9 in the afternoon, the crypto world was still fine but it went downhill in the evening.

Now, a week later, Terra (Luna) is worth practically nothing. The UST is currently at less than 10 cents instead of 1 dollar.

So, what does that mean?

This means that many owners of one or both coins now receive only a fraction of the value from a week ago. Say: If you would have sold Terra (Luna) worth 1.000 $ last week, you will now get less than one cent for that. With 1,000 $ in UST last week, there remain scarcely 80 $ now. And nobody knows how it will continue. Maybe UST will also drop to nothing, maybe both coins (somehow) recover.

For many investors, the loss of the investment is not only a potentially catastrophic loss of money but also a loss of confidence in probably the entire crypto world.

The whole thing is remotely comparable to the Wirecard scandal, where many people also lost assets in a very short time. With the difference that with Wirecard there was actually news about a “scandal”. And: Since then there are investigations, reports and discussions. Well, that’s not the case for Terra (Luna) and UST – as far as I know.

We would now like to draw some parallels to the “known business world” to make what happened a bit more tangible.

Today, we are talking about the basic system of UST and Terra and how that could lead to a kind of hyperinflation.

The monetary principle:

First, let me pose a question: What was a currency again? A currency is a kind of substitute that you can exchange for something while there’s a guarantee that the person who accepts the currency will also be able to buy something with that currency at the same value. This saves, for example, the baker giving out bread directly in exchange for a haircut .

The guarantee is the sticking point here. Normally, a state (or several) guarantees that a currency is worth something and will being worth more or less the same in the future. The state can also prove this, for example, by guaranteeing an exchange for gold in a fixed amount. Colloquially: “Well, if the currency is no longer any good, then we'll just exchange it for gold and that's definitely a good substitute”. As long as all participants in the currency system trust the currency, the whole thing works quite well. In Germany, the last major “currency problems” were the GDR mark shortly before the dissolution of the GDR, or the switch to cigarettes as a replacement-currency for the Reichsmark after World War II. In both cases, the trust in paper money was no longer really there and, well, if the currency is not trusted, then it is no longer worth what it used to be.

Hyperinflation - what is that?

Most people in Germany and Europe know inflation - especially in the current times - but do not have experienced hyperinflation. The last hyperinflation in Germany was about 100 years ago, started shortly after the First World War in 1914 whereas the “hyper” part of the inflation only really started in 1923.

What had happened here?

First of all, in 1914 the “redemption” of the Mark in gold was abolished. In other words, there was no longer any guarantee that one would get a certain amount of gold for the mark. After that - to put it very simply - money was printed. Mainly after the war, in order to pay reparations. The money supply was increased (“inflated”) massively but the value was not. So, the Mark became more and more worthless and soon you couldn't buy anything with it anymore, respectively the prices became higher and higher each day

Bringing gold back into the story:
At the end of 1917 - before hyperinflation - a troy ounce of gold cost 100 marks. In 1923, it cost more than 80 trillion marks.

And what does this have to do with Terra (Luna) and UST?

UST and Terra (Luna) are parts of a digital currency system and both have now become (nearly) worthless through a similar mechanism. Terra (Luna) disintegrated because of a kind of “hyperinflation” - coupled with loss of confidence in the currency and panic selling.

For the stable coin UST (i.e., the stable “currency”), since it was created, there was a guarantee that the holder could always exchange a dollar in UST for a dollar in Terra (Luna). Terra (Luna) is the UST's gold so to speak and the UST should always cost a dollar as a result.

It became problematic now because the price of UST dropped to below one dollar, making the following practically possible:
It was suddenly possible to buy significantly more than one UST for one US dollar. As a result, more Terra (luna) could be bought for one US dollar than should have been possible.

So, it was very attractive to buy UST, exchange them for Terra (Luna) and sell Terra (Luna) directly back on the market. Strongly simplified this means as much as “Let's buy 10.50$ for 10$”.

The connection of UST and Terra (Luna) works in a way that when UST is exchanged for Terra (Luna), the Terra (Luna) is “printed” and the UST is “burned”. So it's more of a conversion than an exchange.

This led to a big selling pressure on Terra (Luna) and - you know it that thing with “supply and demand” - the price of Terra (Luna) dropped as a result.

At the same time, there were a lot of new Terra (Luna) being created, which kept adding to the pressure. Owners of Terra (Luna) have also further boosted sales so that they would have something left of their own investment.

The total amount of Terra (Luna) available grew rapidly from ~350 million to ~6.5 trillion. Welcome to hyperinflation. Amendment: Our analysis shows that this hyperinflation happened after the downfall – at least if the data that is available to us is correct.

The same downward spiral need not have occurred with UST, but the price could not be stabilized and, as I said, is currently pretty much at the bottom as well. To bring gold into play again: Just over a week ago, a troy ounce of gold cost about 23 terra or 1800 UST (or 1800 US dollars). Today, a troy ounce of gold costs either 1800 US dollars, almost 22,000 UST or 10.5 million terra.

After this disaster, one can ask quite a few questions, some of which we will briefly answer. In addition, we are currently doing some analysis and investing whether this crash could have been identified in the data before it happened.

Will the same thing happen to bitcoin now?

No, bitcoin does not have comparable mechanics. Actually, it becomes more and more costly to create new Bitcoin over time. Moreover, the maximum total amount of possible Bitcoin is limited. So a “hyperinflation” like this cannot happen. However, if suddenly all people were equally of the opinion that Bitcoin was worth nothing, then Bitcoin would be worth nothing. However, we think this is extremely unlikely.

Is that the end for the crypto market?

Probably not, although trust has taken a massive hit. There are already a number of theories circulating out there about the actual cause of the Terra (Luna)/UST crash and whether it could have been deliberate manipulation. Anyway, we obviously don't know how long it will now take for the crypto market to recover.

Can the same thing happen again?

Yes, in principle it can. There are some coins that are similarly connected like Terra (Luna) and UST. We are also working on various analyses to identify the risks. Currently, we are planning to include these risks in our Coinformation scoring framework in the future.

What should I do now, should I buy Terra/UST?!

This is definitely up to yourself. In any case, it is not more than a bet in the casino. I personally believe that money invested now in Terra (Luna) or UST could also be burned right away with about the same result: the money is gone. In this respect, I myself will invest at most a few euros (you never know, maybe there will be a recovery...).

We'll post some more on this in the next days and post it on Instagram and in our blog.


Terra Luna's Crash (Banner)

23 May 2022

Terra Luna´s Crash

The second article on the Terra Luna case reconstructs the possible causes and shows how the crash could have happened.

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Disclaimer: Cryptocurrency investments carry considerable risk of loss. The value of your investments can go up as well as down. Please do your own research before investing in any cryptocurrency. This service is for informational purposes only and is not financial advice.

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