Episode 168: TerraUSD meltdown, part 4: TerraUSDs fatal flaw

Welcome to the cryptohunt jam where we spend one minute a day to explain crypto. In plain english.

Welcome to part four of our one-week special on the TerraUSD collapse. Today: How did TerraUSD collapse?

Remember last episode, where we explained how an algorithmic machine can create a stable price for eggs between you and your friends? If not, jump back one episode to 167 because you’ll need the background.

So now we understand that through the process of guaranteeing a stable exchange rate between eggs and dollars, and creating or destroying each in that exchange, we can stabilize prices.

And that’s exactly how Terra worked. It has a sister currency called Luna and the two work just like those eggs and dollars. Get it? Terra - earth, grounded, stable. Luna - moon, space, volatile in value.

The algorithm, just like your magic egg-dollar machine, is the rubber band between the two: It exchanges Terra for Luna and vice versa for a fixed rate, while destroying either one of the other in the process.

But what could possibly go wrong? The system seems solid, doesn’t it?

Well, say the unthinkable happens in our egg market: Overnight everyone turns into a vegan and wants to sell their eggs immediately. That machine would have to act very fast. Destroy egg! Print dollar! Destroy egg! Print dollar!

But every machine has its limits. So did the Terra Luna exchange algorithm. It collapsed under the weight of too many requests to exchange.

In the next episode: Let’s look at the history of what exactly happened on May 9th 2022, and why the Terra Luna machine was flooded with withdrawal requests.

Disclaimer: This podcast references our opinion and is for information purposes only. It is not intended to be investment advice. Do your own research and seek a duly licensed professional for investment advice.