Last week the Terra/Luna ecosystem crumbled before our eyes and is a poster example of why regulation is a good idea:
Terra is its own blockchain (like Bitcoin and Ethereum), which mission was to bring a trustworthy and reliable stablecoin solution to the crypto world. Terras stablecoin was pegged 1:1 to the value of the US Dollar. Stablecoins must be worth $1, because their whole point is to be worth $1. But why would anyone want to own a stablecoin? The reason is simple: the protocol paid ~20% interest to lock up your coins – allegedly risk-free 🙈. Think of it as an extremely high-yield savings account.
Unlike other stablecoins, Terra was an algorithmic stablecoins, meaning that it is deeply undercollateralized: It had only had $2.5 Billion worth of assets in its vault to back the ecosystem. They had, however, issued over $14 Billion in stablecoins. Terra was supposed to handle this with the help of some algorithms that burned a supporting currency, combined with buying Bitcoin when needed.
This is where the problem started: Someone (we still don’t know who) took out a loan of ~ $ 350 MM and started shorting the stablecoin. The plan? To repurchase it cheaper and return what they borrowed. This caused the ecosystem to come under tremendous pressure, and the stablecoin suddenly was worth $0.80, and everyone started selling in panic, causing it to fall even more. At its lowest, it was worth $0.05.