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Cryptocurrency price: why has Luna crashed so much?

It has been a tough few weeks for crypto markets and Bitcoin and Ethereum have suffered from a loss of confidence after the Luna price collapse.

Cryptocurrency Luna slumps to zero
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After enjoying an extremely profitable 2020 and 2021, cryptocurrency investors have felt a harsh backlash this year as a number of widely-held coins have plummeted in value.

Last week we saw perhaps the most abrupt of all the falls when the value of Luna cryptocurrency fell from a combined $20 billion to close to zero in just a few days. At one point the coin was listed at $0.00 on Binance, the most widely-used cryptocurrency exchange in the world.

It’s losses have spooked other investors, spreading across the biggest coins. Bitcoin lost 17% of value in five days, and the price of Ethereum fell by 23%.

How does Luna work?

Ironically, given the extreme volatility of the past week, Luna, or Terra Luna to give its full name, is supposed to be a ‘stablecoin’. Unlike most cryptocurrencies, the value of stablecoins are tied to another asset to prevent wild price swings.

They can be linked to traditional financial networks through bonds or real-world currencies like the dollar to ground them at a certain price point. In the case of Luna, its value is tethered to Terra USD which uses complex mechanisms to keep its value tied to the US dollar.

The price of Luna can fluctuate, but if its value compared to the dollar shifts too much then investors will simply convert it to the more valuable currency, serving to level out the values.

Why has the price of Luna fallen so much?

The catastrophic fall in Luna values came when TerraUSD, the currency essentially guaranteeing a stable price, became quickly devalued.

TerraUSD was tightly linked to Anchor Protocol, essentially a savings account for the currency which paid a 20% rate of interest. This made holding TerraUSD a very popular investment and one that appeared to guarantee very solid returns.

However in March Anchor announced that it was replacing the 20% rate with a variable rate, expected to be far less generous. This saw a mass exodus from Anchor, prompting more holders to sell both their TerraUSD and the closely linked Luna coin.

With huge numbers of people trying to dump their Terra USD and Luna simultaneously the mechanism designed to guarantee stable rates simply stopped functioning.

By Friday 13 May the price of Luna had fallen below 1 cent while TerraUSD, supposed to be worth one dollar, slumped to $0.14.

Writing on Twitter Do Kwon, creator of both TerraUSD and Terra Luna, assured investors: “I understand the last 72 hours have been extremely tough on all of you - know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this.”