3 Lessons Crypto Investors Can Take Away From the LUNA Crash

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  • LUNA's dramatic fall from grace caught many investors unaware, including big players.
  • The golden rule of crypto investing is to only invest money you can afford to lose.
  • Don't assume there are any consumer protections in crypto -- you really can lose everything.

Here's how to protect yourself against future crypto collapses.

The collapse of Terra's network shocked many in the crypto industry. As its ecosystem imploded, the value of LUNA and UST tokens plummeted, quickly wiping out around $40 billion of value. Even established players like Binance and Galaxy Digital lost money.

It is heartbreaking to read the accounts of people who suffered when the Anchor protocol disintegrated. Anchor promised interest rates of almost 20% on UST deposits, but many investors were not aware of the risks involved. According to a Twitter survey, some people lost their life savings. Indeed, 87% of those who lost money said it had severely impacted their mental health.

Crypto investors have a lot to deal with at the moment. Prices have been trending downward for over six months and many people have seen the value of their portfolios halve or more. The LUNA crash showed that even a top 10 crypto can disintegrate in a short space of time. Here are some lessons we can all learn from recent events.

1. Only invest money you can afford to lose

The golden rule is to never invest money you need. These are high risk and often experimental investments and while you may hope for high returns, you also need to be prepared for collapse. A lot of successful crypto investing is about risk management. For example, make sure crypto only makes up a small part of your overall investment portfolio. And within your crypto investments, don't go all in on any individual altcoin, no matter how promising it sounds.

2. Don't trust things that sound too good to be true

There are all kinds of incredible offers in the world of crypto and decentralized finance (DeFi). For example, some decentralized exchanges offer yield farms with APYs of over 100%. And many DeFi protocols offer much higher interest rates than traditional savings accounts. Be cautious as you can often lose money on these platforms.

For example, people trusted Terra's much publicized 20% interest rate on the Anchor protocol. The trouble was that it couldn't sustain it. The high APY wasn't what caused LUNA and UST to enter a death spiral, but the whole system was built on flawed fundamentals. Don't assume crypto is somehow magic and the normal rules of finance don't apply. If an APY is extraordinarily high, find out why before you invest.

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3. There's no consumer protection in crypto

Savers used to the world of traditional finance could be forgiven for assuming the worst thing that could happen with the Anchor protocol was that the APY would fall. Unfortunately, it’s now become clear, that's not the case. The worst thing that can happen in crypto is you lose everything. DeFi platforms are not a good place to put your life savings.

The cryptocurrency industry can be the wild west and the protections that have taken decades to evolve in the normal financial world don't exist. In traditional banking, for example, your account is protected by FDIC insurance for up to $250,000 per account. If the bank fails, the FDIC will ensure you get your money back. People talk about the benefits of becoming your own bank, but they don't talk as much about the downsides. When things go wrong, you're on your own.

Bottom line

Cryptocurrencies might outperform the market in the coming decades, but there are no guarantees. So prioritize other financial goals such as your emergency fund, debt payments, and retirement savings. Most of all, don't be deceived by professional-looking crypto exchanges and platforms. Blockchain technology is still in its infancy, and many parts of the DeFi market can be incredibly risky.

Do as much research as you can on any individual crypto before you invest, and don't assume that a project is safe just because it has a high market cap. The best way to invest in cryptocurrency is to position yourself to benefit from any gains, but insulate yourself against losses. Hopefully that means you'll never be in a position where you face financial devastation because the crypto market crashed.

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