TerraUSD meltdown, part 3: How TerraUSD worked - the story of the magic egg-dollar machine - Crypto in Plain English - Episode 167 - by cryptohunt.it

TerraUSD meltdown, part 3: How TerraUSD worked - the story of the magic egg-dollar machine

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

Welcome to part three of our one-week special on the TerraUSD collapse. Today: How did TerraUSD actually work before it collapsed?

The people behind Terra wanted to create a stable coin for easy online payments. And a decision was made: Let’s use a self-stabilizing algorithm instead of central reserves.

So, let’s look under the hood and explain how that works… with an analogy as always. Let’s go!

Say that you and your friends agree that – from now on – one egg is always worth one dollar. You all keep your promise for a while and trade happily, until one friend gets tired of eggs and wants to dump them all for 80 cents a piece. Suddenly, the entire market adjusts, and egg prices aren't stable anymore.

So you invent a really powerful machine: It can create eggs, destroy eggs, print dollar bills, and burn dollar bills.

And the machine operates by two basic laws:

Law one: If you give it a dollar, it burns it and creates you an egg.

Law two: If you give it an egg, it destroys it, and prints you a dollar.

Immediately, everyone would see the opportunity: Buy those cheap eggs directly from your friend for 80 cents, and exchange them for a full dollar through the machine. They just made 20 cents, a 25% profit!

Bankers call this arbitrage and they love it. Once they are in on the action, there are soon only eggs worth $1 left for sale. And whenever a small discount pops up again, the bankers will make sure to close that.

Your magic machine just created stable-eggs. And it’s exactly like that algorithm that powered TerraUSD.

And in the next episode, we’ll look at the machine's fatal flaw.

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.