Crypto Crunch Threatens Conventional Assets Terra (LUNA), an important digital coin in the Terra ecosystem that was supposed to be pegged to the U.S. dollar, crashed last week to near zero, and it's having a far-reaching impact on stocks, bonds and other risk assets.
LUNA has fallen from $116 in April to $0.000167 as of writing. When the UST peg broke, panic ensued and investors sold risk assets of all stripes.
For many investors, this contagion effect feels like déjà vu. The Russia and Asia currency crises of the 1990s roiled markets and wiped out fortunes.
The news seemed to come out of nowhere, then everything suddenly went off the rails as investors learned about exposure at money center banks in the U.S. and in Europe.
A Valuable Lesson for All Investors
Crypto has become a substantial investment category in a short period of time. It's the perfect trap for performance chasing among leveraged professional money managers.
To get a better understanding of the situation at hand, let's start with Terraform Labs.
The blockchain project was developed by Do Kwon and Daniel Shin, graduates of Stanford and the University of Pennsylvania, respectively.
The pair thought they could disrupt the global payments system with a low cost blockchain alternative. To eliminate cryptocurrency volatility, Terra engineers built a suite of decentralized digital coins pegged to real world, fiat currencies like the U.S. dollar, Korean won and the euro. The twist was these so-called stablecoins were not backed by actual fiat currency holdings.
The peg was maintained by a clever arbitrage relationship with LUNA. The Terra ecosystem permitted unlimited swapping of LUNA for UST, and vice versa.
If UST deviated from its $1 USD peg, traders would be incentivized to buy or sell LUNA outside of the ecosystem, then swap it for UST inside the Terra ecosystem for a low-risk profit.
This model—called mint and burn equilibrium—depended on economic incentives to stabilize UST, while dynamically adjusting the supply of the underlying parts.
The weakness of the system was that investors were at the mercy of the external market for LUNA coins. If confidence waned or the price fell precipitously, investors would be further incentivized to keep selling LUNA to swap into UST, creating a death spiral of sorts.
Anchor was the third rail in the Terra ecosystem. It existed to create demand for LUNA and UST. Anchor offered investors huge incentives to park assets in the ecosystem. It was essentially a Terra savings account with a promised 20% annualized yield.
In hindsight, UST, LUNA and Anchor were all too good to be true. UST was supposedly pegged to the U.S. dollar, although the structure held no dollars.
UST was interchangeable with LUNA, yet neither was supply constrained. And Anchor offered savers a 20% yield. The ecosystem worked so long as LUNA coins were increasing in value.
Once the value started declining, problems quickly ensued. In early April, the alternative coin soared to $116. Now, a month later, it's practically worthless. | 
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