[Insight & Opinion] Terra and Luna Crash Triggers Seismic Shift in Cryptocurrency Market

Professor Jeong Yushin

The sharp crash of Korean virtual currencies Terra and Luna is causing a major shock and damage to the cryptocurrency market. Luna's price, which once rose to $119 (about 153,000 KRW) last month, plummeted nearly 100% to 0.3~0.4 KRW by mid-May. As a result, the world's largest cryptocurrency exchange Binance and domestic exchanges Upbit, Bithumb, and Gopax have effectively delisted Luna, and due to the severity of the crash, there are growing concerns about further shocks to the cryptocurrency market and even the broader financial market in the future.

Why did it crash so drastically in such a short period? Industry insiders believe that recent U.S. interest rate hikes have destabilized the cryptocurrency market, and hedge fund short-selling attacks acted as a trigger for the crash. However, the fundamental reason is widely believed to be a fatal flaw in the product structure of Terra and Luna. To increase demand for Terra and Luna, the Anchor Protocol was operated, offering an annual yield of 20%, but there were many doubts about whether asset management capable of continuously providing such a high 20% return was truly feasible. Ultimately, aggressive high-risk, high-return asset management, such as Bitcoin investments, was inevitable, and hedge funds attacked the resulting vulnerabilities, leading to the crash.

There is also an opinion that the name "stablecoin" contributed to the expansion of the damage. Although it was presented under the guise of an algorithmic stablecoin, it is common knowledge in the asset management industry that aggressive high-risk, high-return management cannot maintain coin value stably (stable).

What ripple effects can be expected going forward? First, changes in the market landscape and structure of stablecoins are anticipated. Stablecoins are divided mainly into three types by market capitalization: USDT, commonly known as Tether; USDC (USD Coin), which deposits dollars in major U.S. banks and is considered the most stable; and UST (Terra). Following the Terra incident, many expect algorithmic stablecoins to decline and a reorganization centered on USDC, which emphasizes "stability." A phenomenon of funds flowing into USDC is already occurring. While the market capitalization of most cryptocurrencies, including Bitcoin, has decreased by 20-30%, USDC has risen more than 5%, surpassing 65 trillion KRW to reach an all-time high. There are also opinions that when the U.S. Federal Reserve issues a digital currency (CBDC) in the future, it may be linked to USDC.

Opinions suggest that the chain crash has calmed down for now. However, the U.S. Federal Reserve plans nearly monthly interest rate hikes, and monetary tightening will begin next month. If a fund run occurs in the stock, bond, or cryptocurrency markets, a domino effect of sell-offs to raise cash could happen.

Regulation of cryptocurrencies is also expected to accelerate. Not only U.S. Treasury Secretary Yellen but also members of the U.S. Congress continue to emphasize the need to protect investors in the cryptocurrency market, raising the possibility of enacting a virtual asset regulation law within the year. Additionally, the U.S. is rushing to enact virtual asset regulation laws to strengthen the vulnerability of digital dollar hegemony revealed by Russia's invasion of Ukraine. The first measure was President Biden's signing of an executive order directing cryptocurrency research in March; the second is the rapid progress of virtual asset regulation laws triggered by the Terra incident; and the third is likely the future issuance of the U.S. Federal Reserve's digital currency (CBDC) and the reorganization of the cryptocurrency market centered around it.

South Korea is also hastening the Digital Asset Basic Act, a presidential campaign pledge, to promptly resolve risks caused by the "non-institutionalization" of cryptocurrencies. It is said that the policy direction for virtual assets is likely to shift rapidly from activation to regulation. It is hoped that a balanced legal system and policy will be established that accurately identify the problems and create investor protection measures while also considering global policy changes to foster new industries utilizing virtual assets.

Jung Yoo-shin, Dean of the Graduate School of Technology Management, Sogang University