By now, investors with a passing interest in the cryptocurrency sector – and even many of those who don’t – have heard about the implosion of Terra (LUNA-USD). Essentially, the market value of Terra was undergirded by TerraUSD (UST), a stablecoin or a class of digital assets that are pegged to a hard currency, typically the U.S. dollar.
In arguably most cases, stablecoins are backed by physical reserves. Theoretically, if a “bank run” occurs in the blockchain, the issuers of legitimate stablecoins can exchange on a one-to-one basis the dollars they represent. What made UST unique from its rivals is that it deployed a complex algorithm facilitating a decentralized incentivization platform that sparked a series of minting and burning actions to achieve an equilibrium.
It was a cracking innovation so long as it worked. From its public debut to a fateful series of trades in May of this year, UST ran its magic. In doing so, the value of the LUNA cryptocurrency soared. Regarded during the pre-crash years as one of the most groundbreaking developments in blockchain technology, Terra literally forced onlookers to recognize an earth-shattering new economic paradigm.
That was until the implosion occurred. As The Washington Post detailed, UST suddenly lost its peg to the U.S. dollar. Being intertwined with the stablecoin, Terra suffered a catastrophic loss of market value as investors lost confidence in UST’s algorithmic protocol. The cancer quickly spread to the broader crypto market, sparking a loss of over $500 billion.
What on Earth to do now?
A Critical Indicator to Never be Ignored
Perhaps predictably, in the wake of the LUNA collapse, some crypto speculators have poured into the digital asset, now rebranded as Terra Classic (LUNC). As of the afternoon session of June 26, LUNC’s order book shows bids (buy orders) totaling $26,710. On the other end, asks (sell orders) totaled only $3,428. Though we’re talking about small nominal figures, it’s quite a bull-bear spread.
Evidently, some crypto investors are merely chasing low prices instead of high quality, which is likely to bite them. However, this is not the lesson that observers should take from the Terra fiasco.
Rather, on the eve of the LUNA implosion, analysts covering the crypto space noticed that UST had previously fallen from its 1:1 peg. At one point, UST dropped to 68.4 cents before climbing up to 93 cents per token. Obviously, we know through hindsight what happened next. But the point here is that a stablecoin dipping slightly below $1 per unit could be an early warning indicator of more trouble to come.
Now, let me caveat the last statement by noting that stablecoins are never perfectly pegged at 1:1 with the greenback. Various market conditions can make these units increase or decrease against the $1 mark. However, pronounced declines or perhaps consistent underperformance against the dollar might be the warning sign to get out.
Time is of the Essence
One of the joys of investing in cryptos is that everything seemingly operates on an accelerated timeline. Very roughly speaking, the rise of virtual currencies resembles the rise of the Dow Jones; it’s just that the latter operates on a centuries-long scale whereas digital assets are on a comparatively condensed scale.
On the other hand, the agony of investing in cryptos is also the accelerated timeline. If you blink for a millisecond longer than you should have, you can see your digital wealth evaporate before the impulse to sell out of your position reaches your brain. It’s exactly what happened with LUNA, causing some stakeholders to suffer extreme (and unprintable) despair.
Therefore, anybody who is considering investing in cryptos should only do so with money they can afford to lose. Terra provided the wake-up call that anything and everything can happen in the crypto space. More importantly, once you decide to exit a certain position, you should do so quickly and decisively.
Unlike a regulated exchange, there is no “plunge protection team” to cut the circuit breakers to give market participants a cooling-off period. Because cryptos trade 24/7/365, whoever sells first in a panicked selloff is guaranteed the best rate. It goes without saying that under such extreme circumstances, you are much better off exiting with market orders rather than limit orders.
Simply put, you won’t have any assurances that you’ll be able to sell your assets at the limit price.
You Have No Friends in Crypto Land Either
An old adage states that you have no friends on Wall Street. In relation to a benchmark, the capital markets roughly represent a zero-sum game. Basically, in order for you to win, someone else has to lose. Therefore, human emotions such as friendship get in the way of the primary objective of stock trading: making money.
But you’ve got to remember that the cryptocurrency sector – despite the myriad advertisements of community-driven ecosystems – also is an unfriendly enterprise. The folks that created LUNA? They shamelessly minted another similar crypto, essentially a LUNA 2.0.
So far, this replacement LUNA is a loser – a steep one – against its debut price point.
And this leads to a final lesson. Should you decide to get involved with a crypto coin or token, do so because you have a strong conviction in the underlying project. Treat any marketing pitch pumping up the asset as noise from a used-car salesperson. Chances are, that’s all it is.
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