This is a post-mortem of the Terra/UST depegging. Learn everything you need to know about the situation here.
- Luna And UST Relationship
- UST Depegging
The crypto market has faced an unprecedented crash, due to which the prices of popular cryptocurrencies such as Bitcoin, Ethereum, and many others went down sharply after nearly two months of constant redness. Ethereum and Bitcoin are both down over 30% week-over-week. The decline was rapid but the reason behind this massive crash was the truly horrific crash of LUNA. Terra Luna (LUNA) lost over 85% of its value till May 11th, as per Coin Market Cap data. Today, the price of LUNA is now less than a fraction of a penny, which is a mighty fall, considering that its all-time high of $118 was seen in April. The reason behind this spectacular crash was the “depegging” of Terra USD (UST) stablecoin. UST had dropped to $0.45 from its value of $1. This had counted for about a 55% drop in the market at that time. Since both UST and LUNA are interlinked, this massive drop in UST value has resulted in LUNA’s overall drop.
RELATIONSHIP BETWEEN LUNA AND UST?
Terra is a blockchain network just like Ethereum and Bitcoin. Terra natively produces LUNA. In order to create UST, one has to burn LUNA. As more people buy into UST, more LUNA would be burned, which makes the remaining LUNA supply more valuable. Since UST is a stablecoin and is special in the sense that it was an “algorithmic” or “decentralized” stablecoin. It means that, unlike other stablecoins, it is not backed by actual cash, but by a more clever mechanism in which about $1 billion of bitcoin reserves were used to maintain UST’s peg.
UST can retain its peg when 1 UST is exchanged for $1 worth of LUNA. So if UST slips to 99 cents, traders could profit by buying a huge amount of UST and exchanging it for LUNA, profiting one cent per token. This thing works in two ways. People buying UST drives the price up, and UST being burned during its exchange to LUNA deflates the supply. It means that when the price of UST is too high, users are incentivized to burn LUNA and create new UST, increasing the stablecoin’s supply, while also decreasing the amount of Luna in circulation. Similarly, when UST’s price is too low, the reverse happens-UST gets burned and LUNA is minted- which stabilizes the prices.
Stablecoins are cryptocurrencies pegged to fiat currencies such as the US Dollar on a 1:1 basis. Depegging refers to the stablecoins going above $1 or more commonly below $1. There is another way to protect UST’s peg to the dollar. It is called LFG (Luna Foundation Guard). The LFG had about $1.5 billion in Bitcoin reserves. If UST dipped below $1, bitcoin reserves would be sold and UST bought with the proceeds. If UST goes above $1, creators would sell UST until it goes back to $1 with the profit being used to buy more Bitcoins to pad out the reserves.
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WHAT LED TO UST DEPEGGING?
Despite all the measures taken by Terra to ensure that UST remained stable, something went very wrong in the crypto market. Over $2 billion worth of UST was unstaked (taken out of the Anchor protocol), and hundreds of millions of that was sold immediately. Such a huge sell pushed the price down from a concerning $0.985 to a shocking $0.90, then $0.85 then $0.80, and then even lower. However, when the price lowered down to 91 cents, the traders tried to take advantage of the arbitrage (exchanging 90 cents worth of USD for $1 worth of LUNA). But only $100 million worth of UST can be burnt for LUNA per day.
The investors who were already fighting the current gloomy market flocked to sell their UST once the stablecoin couldn’t retain its peg. After it reached its lowest value of 30 cents on Tuesday, the coin rebounded to 44 cents which were again far below its $1 goal. Its market cap was around $18 billion just a week ago and now it stood at almost $994.17 million. It is also in stark contrast to its all-time high market cap of around $25 billion. Likewise, before the depeg, LUNA was trading at $85.
One of the speculations regarding this malicious attack was that an attacker attempted to break UST in order to profit from the shorting of Bitcoin. It means betting on Bitcoin’s price going down. If the attackers created a large position in UST and then unstaked $2 billion at once, it could depeg UST, so Terra would have to sell portions of its Bitcoin reserves to re-peg the stablecoin. And once investors saw that UST lost its peg, they would rush to unstake and sell their UST, thus requiring more Bitcoin reserves to be sold, adding further sell pressure. Resulting in Bitcoin losing its value, and the attackers gaining profit from their position.
WHAT IS ITS AFTERMATH/CONCERNS?
Approximately $15 billion in crypto value has been wiped out through LUNA and UST alone. It is obvious that a lot of people lost a lot of money in the collapse. This damage isn’t contained only to the Terra ecosystem, many who were exposed to LUNA and UST would have sold them fearing that it may go to zero, selling them to get rid of it sooner rather than later.
Furthermore, this incident also raises questions about other stablecoins. Boroughs worries that if UST was attacked, similar plays could be made against the others. He said, “The question in our minds becomes, does what happened to UST spread to other stablecoins? If big whales found a playbook here that works to attack UST, we worry they may reuse that playbook in other areas of the market.”
Finally, the collapse of UST has also called the attention of powerful politicians and regulators. Janet Yellen, Secretary of Treasury said, “UST’s depegging illustrates that this (stablecoins) is a rapidly growing product and there are rapidly growing risks”.
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