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Why TerraUSD and Terra Are Falling Today

What happened

Over the last 24 hours, the price of the algorithmic stablecoin TerraUSD (CRYPTO: UST) and its sister cryptocurrency Terra (CRYPTO: LUNA) continued to trade with intense volatility.

The price of TerraUSD has plunged more than 31% as of 10 a.m. ET today, while the price of Terra has fallen more than 30%.

So what

Founded by the influential South Korean crypto developer Do Kwon, TerraUSD is a popular algorithm stablecoin. Traditional stablecoins are digital assets backed by real assets such as a fiat currency or commodity. Algorithmic stablecoins, on the other hand, use complex technology to maintain their peg to these assets but are not actually backed by them.

TerraUSD uses a complex minting-and-burning process with Terra to maintain its peg to the dollar. The price of Terra can fluctuate more broadly, but the price of TerraUSD is supposed to maintain a one-to-one peg with the U.S. dollar.

Computer showing stock chart on the decline.

Image source: Getty Images.

However, in recent weeks, as the price of Bitcoin and other cryptocurrencies plunged, TerraUSD lost its peg to the dollar and collapsed, triggering broader concerns in the crypto market. Terra has a reserve of Bitcoin that many feared the network would sell to rescue TerraUSD, flooding the market with supply.

The current price of TerraUSD was below $0.09, and it has a market cap of less than $1 billion as of this writing. At its height, TerraUSD had a market cap of more than $18.5 billion and was the 10th-largest cryptocurrency in circulation.

Since the collapse, Kwon has announced a rescue plan and said TerraUSD will be backed by reserves in the future, which will make it more like a traditional stablecoin.

Now what

Algorithmic stablecoins have always been considered incredibly risky, and none have really been a success story. The fall of TerraUSD will only lower confidence in the concept. Given what just happened, I would certainly recommend staying away from TerraUSD and Terra.

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Bram Berkowitz has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin and Terra. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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