The largest cryptocurrency failure ever happened this week as LUNA coin went from $86 to $0.00002 in what appears to be a deliberate attempt to tank its value and drag bitcoin down with it.

LUNA is the base coin for the Terra project, and works hand in hand with UST (TerraUSD) which is pegged to the dollar. But unlike other dollar pegged coins, UST is not backed by any assets. It is pegged to the dollar by an algorithm which became a formula for a death spiral.

To create UST, you need to burn luna. So for instance, last week you could trade one luna token for 85 UST (since luna was worth $85), but the luna would be destroyed ("burned") in the process. This deflationary protocol was meant to ensure luna's long-term growth. As more people buy into UST, more luna would be burned, making the remaining luna supply more valuable.

To entice traders to burn luna to create UST, creators offered an insane 19.5% yield on staking -- which is essentially crypto terminology for earning 19.5% interest on a loan -- through what they called the Anchor Protocol. Instead of parking your savings at a bank for a 0.06% [SIC] interest rate, the pitch is to turn put your money into UST, where it can earn nearly 20% in interest. Before Saturday, over 70% of UST's circulating supply, around $14 billion, was deposited in this scheme.

Here's the key to UST retaining its peg: 1 UST can always be exchanged for $1 worth of luna. So if UST slips to 99 cents, traders could profit by buying a huge amount of UST and exchanging it for luna, profiting one cent per token. The effect works in two ways: People buying UST drives the price up, and UST being burned during its exchange to luna deflates the supply.

This story begins on Saturday May 7, 2022, several days before the crash, when an entity who had recently accumulated $1 Billion worth of UST shorted Bitcoin and then started dumping UST into the market so fast that the algorithm couldn't maintain the dollar peg.

Losing 1:1 value with the dollar sent shockwaves through the UST / LUNA ecosystem and it was like a bank run with everyone trying to cash out. The rest, as they say, is history.

LUNA, which was at one time worth $120 with a $40 billion market cap, plummeted to practically zilch.

It is much easier to get a margin trading account at a crytpcurrency exchange than it is with a securities broker, all one needs to do is hold one of the coins approved for margin on that exchange.

As a top 10 cryptocurrency, LUNA was the basis for many margin accounts. Traders had bought LUNA on margin, and used their LUNA assets to buy bitcoin on margin. For many traders, LUNA and bitcoin were their two biggest holdings.

As the price of LUNA crashed, it forced a liquidation of assets that affected a far ranging basket of cryptocurrencies. Bitcoin, which had already broken down to $34K, lost another $7,000 and $130 billion in market capitalization.

Top hedge funds have denied any involvement, but since there is no penalty for colluding to manipulate currency markets, the culprits have little to fear in reprisals. My hunch is it was a cabal of bitcoin "whales" who are ruthlessly accumulating coins.

Here is an interesting Twitter thread where 6 weeks ago someone wondered what a run on UST might look like, and this response from Galois Capital hit the nail on the head.

The problem is that you can’t actually redeem $11bn UST and settle to a price even close to $5. You might be able to do $7bn with final Luna price very close to 0 like $.000001. You are correct that yields will be extremely high but hyperinflation will be even higher then.

— Galois Capital (@Galois_Capital) March 23, 2022

Sharks patrol these waters
Sharks patrol these waters
Don't you let your fingers dangle in the water