In the middle of the craziest week in cryptocurrency ever, the UST stablecoin of Terra and LUNA token collapse came out as one of the biggest stories here in the Crypto world. LUNA which was amongst the top 10 coins before according to market cap saw a 100 % fall to a fraction of one cent.
UST that has been designed to stay at the $1 peg fell down to 13 cents. Let us check out what happened.
What were the reasons behind Terra’s UST and LUNA’s collapse?
Several forces were at work, The first one is the mechanism behind the token Terra along with its stablecoin. The second one was usual panic.
Various investors who were mainly unaware of why exactly the stablecoin kept on dropping, moved to the exit at a de-pegging’s first whiff. The high-interest savings account of Terra was reducing all rates steadily that it offered holders to deposit UST.
Something that started at 20% and was marketed as something stable started to steadily drop following the Proposal 20 in March. The proposal meant if the reserves of Anchor increased by 5 %, the rate of interest would be increasing.
If such reserves fall by 5 %, the rates of interest will also fall. Such a rate was continuously expected to drop 1.5 % points every month if there were a lot of lenders than any borrowers on this platform. Rates of interest were expected to fall. So the number one use case of UST started to waver.
On 23rd April, over 72% of every UST in circulation got locked up in Anchor. After it was clear that 20% interest was never going to last, holders of UST started to leave.
On 6th May, roughly 14 billion UST was there in Anchor. 11.7 billion was the figure by Sunday. Then UST was still pegged to the dollar.
It means that roughly $2.3 billion in cap took flight during the last weekend. Holders of UST were interested only in the network of Terra due to Anchor. So their departures meant there was no further UST use. Thus there was a mass exit.
For exiting UST, there are two options. The first one is the burn-and-mint mechanism of Terra. Such a mechanism allows the holders to swap 1 UST for Luna $1 destroying all UST during the process.
It creates an arbitrage chance if 1UST falls under $1 because speculators will be able to buy the discount one and then trade it for $1 in LUNA. Thus they can make a small profit. If UST is trading above $1, you will be able to swap or burn LUNA of $1 for that UST. The second option is approaching Curve Finance, the stablecoin exchange.
Usually, if a stablecoin faces any minor change in price, savvy arbitragers will be heading over to the deepest liquidity pool of DeFi on Curve and then trade the discounted one to any alternative that it is pegged. So for example, if DAI trades at $0.99, investors will be buying the discounted one and selling it for USDC to earn a profit. This buying pressure will normally push the DAI price back to $1. It is true too for UST.
Terra is a blockchain network. It encounters all gas fees for activity. With a higher gas fee than normal, the Terra network is too limited in terms of how much LUNA or UST can get minted or burned at once.
As things were slow, crypto exchanges started to push withdrawals. Such a mechanism may also have an effect on LUNA’s price.
Is Terra capable of surviving?
According to Cointelegraph, Polygon is now providing Terra projects a permanent place, whilst BNB Chain is offering financing and support to anyone looking to leave the Terra ecosystem. Terra would become even less meaningful as a result, undermining the justification for preserving the biosphere.
Denko Mancheski, CEO of Reef.io, tweeted in mid-May that $200,000 in funds is ready to be deployed to help Terra startups seeking for a home with tech onboarding and community assistance.
The price of LUNA constantly plummet as many ditched UST and sold their LUNA token. Eventually, the price of LUNA became very low.
There was not sufficient runway for UST. It created a huge bad debt amount. Terra community doubled down. They opened up the total LUNA that can get minted at once. Yet this accelerated the spiral.
On 8th May LUNA was having a circulating supply of 343million. On 12th May, these figures blow up to 32.3 billion.
Despite the negativity of the feedback loop, the community of Terra proposed some more emergency actions. It is all about lighting UST and not minting LUNA as much as possible. If you are looking to invest or trade cryptos check out Bitcoin smart.