LUNA’s price falls to pennies as
UST stablecoin slump deepens

Posted: 12 May 2022 6:30 pm

LUNA, once a top 10 cryptocurrency by market cap, lost more than 99% of its value within days. Can LUNA and the stablecoin UST be saved?

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The plunge in the UST stablecoin and its sister Terra worsens despite efforts to salvage them.

TerraUSD (UST), a stablecoin on the Terra blockchain that’s supposed to hold a value of $1, dropped below 30 cents within the last 24 hours and has held below 50 cents at this writing.

Its sister coin Terra (LUNA), which helps stabilize the UST to hold that $1 peg, collapsed in a few days from over $80 to less than 13 cents as of this writing. CoinMarketCap shows a 24-hour low of just over one penny.

Do Kwon, founder and CEO of Terraform Labs, outlined an action plan on Twitter to restore the peg and end the damage. But with crypto in general struggling in part due to UST and Luna, that may be hard to pull off.

And it’s possible the problem will spread: A second stablecoin traded below $1 Thursday, though it did bounce back.

The action plan

The first thing the Terraform Labs (TFM) did was increase the speed and rate of burning UST and minting more LUNA to stop speculators from shorting the latter.

The next steps were to:

  1. Burn the remaining UST in the community pool.
  2. Burn the remaining 371 million UST cross-chain on Ethereum.
  3. Stake 240 million LUNA to defend from network governance attacks.
  4. Halt the Terra blockchain to avoid governance attacks.

As of this writing, the Terra blockchain resumed operations with a patch that disables delegations. But it remains to be seen how well these steps will work with LUNA almost worthless.

How UST broke down

Stablecoins like UST are pegged to the value of a set asset, like the US dollar. Their attraction is that they offer investors the advantages of using crypto as a currency without big moves up and down in value.

UST is an algorithmic stablecoin, meaning that instead of being backed by assets like US dollars or US securities, smart contracts are used to increase or decrease its supply to keep its peg at $1.

For example, when the UST slips below the peg, the algorithm burns (or destroys) UST to reduce its supply until the peg is restored. If this doesn’t do enough, the algorithm releases seigniorage shares, which are similar to bonds. Users buy them at a discount with their UST, again reducing the circulating supply.

The algorithm’s third method is to use the LUNA token, Terra’s utility and governance token. If UST drops below the $1 peg, the algorithm incentivizes holders to burn UST in exchange for LUNA.

One of the major ways for UST to increase its adoption has been to incentivize holding it. Anchor Protocol was a decentralized lending platform where investors could use LUNA or other coins as collateral and borrow UST. They could then use the UST they borrowed to earn a 19% annual percentage yield (APY).

Trouble started brewing on Monday

The week started with UST losing its peg and trading at 70 cents for a few hours before the algorithm kicked in and restored the value to above 90 cents. This was still off the $1 peg.

This drove a selloff as investors who had funds deposited on the Anchor Protocol and other Terra platforms started withdrawing and cashing out. Within two days, the total value locked on the Terra platform dropped from around $30 billion to $12 billion. This put even stronger pressure on UST’s price.

Within the next few days, UST fluctuated between 10 and 80 cents, settling at around 40 cents at the time of writing.

How UST hit bitcoin and the broader crypto market

Another entity keeping the UST peg was the Luna Foundation Guard (LFG), a nonprofit organization with the goal to help build and promote a decentralized economy on the Terra blockchain.

The LFG had established a decentralized reserve protocol to safeguard the UST peg. This included $1.5 billion worth of Bitcoin.

Within the first 24 hours, LFG deployed $750 million in BTC to market makers to buy UST and counter the effects of panic-selling. Instead of lifting the UST, this caused a selloff in Bitcoin. Over $1 billion worth of leveraged positions were liquidated within the first day, according to Coinglass.

Combined with an overall financial selloff, this brought Bitcoin prices to a new low for the year.

Interested in cryptocurrency? Learn more about the basics with our beginner’s guide to Bitcoin, dive deeper by learning about Ethereum and see what blockchain can do with our simple guide to DeFi.

Kliment Dukovski owns cryptocurrencies as of the publishing date.

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