UST losing its peg & the effect on Terra (Luna)
$UST is a dollar-pegged stablecoin. Terraform Labs is the company that created and maintains $UST & the Terra Blockchain. Luna is the cryptocurrency supporting the Terra ecosystem. Luna & UST are linked intricately. LUNA must be burned to create UST and vice versa. Theoretically, this signifies that one can exchange 1 UST for $1 of LUNA. The price support mechanisms for UST are semi-automated and function well in most cases, even when there is a lot of volatility. However, under severe cases, such as market demand for LUNA and/or UST evaporating abruptly, they do not operate well. Luna Foundation Guard (LFG) guards the UST’s peg to the dollar. LFG bought a massive amount of bitcoin to add to their treasury. This treasury can be used to protect the UST’s price.
If the UST system was designed so well, what happened suddenly that caused LUNA & UST to crash drastically?
Below, you can see that $UST touched an ATL of $0.2998. A stable coin whose price should revolve around $1 was priced at $0.2. What a huge failure!
What happened actually?
To clarify, the goal of UST is to establish an “algorithmic stablecoin” in which LUNA can be burned to “mint” UST in order to keep it stable anytime it loses its 1:1 peg to the dollar, and vice versa. If UST reaches 0.99, a little amount of LUNA is burned, and if it reaches 1.01, a small amount of UST is burned.
It worked until it didn’t.
As much as we understand, it was a planned attack. Let’s get into the event of attack one by one:
- The Luna Foundation Guard (or LFG) began buying BTC in March to sustain $UST, and by March 26th had a $1 billion BTC holding. This is the first step that made this trade (or attack) so successful.
2. In the first week of April, Terra launched 4pool Liquidity pool claiming that this pool will support UST, FRAX, USDT, and USDC. Before the launch of 4pool, 3pool was the largest stablecoin pool in the market offering deep liquidity for a wide range of stablecoins, including USDC, USDT, and DAI. The liquidity offered by this platform is $3.2 billion. Hence, 4pool’s goal was to attract more people to the platform and maximize rewards. This would have had an adverse effect on 3pool.
3. (This is speculation, we believe this happened. This is not assured speculation)An attacker used the Gemini exchange to borrow 100,000 Bitcoin. They then swapped a big number of BTC for UST at a discount over the counter (OTC) with Do Kwon (Founder of Terra). He agreed, and the UST liquidity was reduced.
4. To reportedly prepare for the launch of 4pool, on May 8, 2022, LFG removed approximately $250 million from the UST-3pool on the stablecoin exchange platform Curve in two transactions. Immediately following the transaction, the attacker swapped $85 million of UST for USDC on Curve and then started dumping their $UST on Binance
5. Terra tried restoring the peg by providing liquidity to Curve. But, people panicked because $btc tanked and also because of small $ust depeg.
6. To protect the peg, LFG begins selling $BTC, and UST nearly returns to $1. $UST de-pegs to 60c at the bottom as a result of the bank run, while $BTC bleeds out.
7. Many investors sold their LUNA holdings and unstaked their UST to sell it, resulting in a liquidation cascade of leveraged longs, slippage, and panic selling.
8. When UST began trading substantially below its dollar peg, users began exchanging UST for competing stablecoins, shrinking the UST Curve pool. Short selling caused the price of LUNA, the UST collateral, to fall. Terra was compelled to mint more LUNA to relieve the negative price pressure.
9. BTC was the perfect playground for the trade, as the liquidity was there to pull it off. While having LFG involved in BTC, and foreseeing they would sell to keep the peg (and prevent LUNA from dying) was the kicker.
On top of this Anchor Protocol (ANC) experienced a price drop of almost 80%. Anchor is a lending protocol on the Terra network, which pays out a yield of up to 20% to UST depositors through yield reserves.
The crisis surrounding UST’s dollar peg has seen users make large withdrawals from Anchor. The users who had their UST staked on Anchor Protocol. These users likely rushed to withdraw their UST deposits so they could no longer be exposed to the volatile stablecoin. ANC has suffered from a similar fate as LUNA, Terra’s main asset used in maintaining its peg. It has declined from $30 to $2, down 93% today.
What does the future hold now?
You cannot foresee a future after a bloodbath massacre. In the last couple of days, crypto has wiped out almost 95% of the investors’ wealth. The market capitalization of Terra tanked below expectations and LUNA is trading at as low as $0.02.
Terra is ranked at 118 positions, while a few days ago it was at 8th position.
The trust in crypto is getting dissolved. After such a huge fallback it will be almost impossible for people to trust the crypto space again for investment. Lots of people lost their life savings in a matter of a few hours. This is not a joke.
On top of this, Terra is minting more and more Luna. You can check out the circulating supply here through this link: https://fcd.terra.dev/v1/circulatingsupply/luna . Basically, $LUNA’s circulating supply went from 340 million to 4.7 billion in 1 day. And, https://fcd.terra.dev/v1/totalsupply/ust UST circulating supply was reduced from 18 billion to 12 billion
Let’s see how Terra foundation will provide support in this time of dramatic fall.
Kwon aims to buy $10 billion worth of Bitcoin with the help of a non-profit foundation Luna Foundation Guard, according to sources. These funds will be used to help people. The difficulty is that, given the current state of Bitcoin’s market, reestablishing the value of a cryptocurrency and a stablecoin may not be a wise approach. This could destabilize not only the Terra ecosystem, but also Bitcoin and, eventually, the entire crypto market.
