Crashes like the Terra Luna collapse make headlines, but don't doom the crypto space just yet
The spectacular meltdown surrounding the Terra stablecoin and Luna governance token might be generating headlines, but it’s no indication that the broader crypto asset marketplace is headed for a collapse.
Stablecoins have quickly moved from a niche area of the crypto sector to a type of crypto asset that has been heralded by many as the best of both worlds.
By combining the functionality and price stability associated with fiat currencies with the speed, security, and lower fee structure of cryptocurrency stablecoins have – rightly so – experienced a dramatic increase in both interest and adoption.
TerraLabs, the parent organisation of the Terra stablecoin, seemed like just the latest entrant to this space, and appeared to have come up with an innovative solution to entice additional investment to the project: an algorithmic stablecoin.
Without diving into too much technical detail, the algorithm underpinning the Terra stablecoin was developed to address the fundamental problem with any stablecoin; how is the stabilisation maintained?
Usually designed to be traded and used as a 1:1 equivalent with the US dollar, stablecoin issuers attempting to achieve commercial scale and acceptance must have a process in place to maintain this valuation.
The algorithm underpinning Terra enabled the automation of this process, versus manual pegging and adjusting the supply of stablecoins, with the aid of smart contracts and the Luna governance token.
For the purposes of this article, smart contracts can be summarised as executable code that is embedded and connected to a blockchain application.
When the price of Terra dipped below or rose above $1, these smart contracts would power the algorithmic process that allowed investors to swap Terra
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