The Terra Luna Ecosystem and UST in Context
UST is the Terra ecosystem’s algorithmic stablecoin, and as such, it is involved in maintaining a $1 to $1 peg through its mint and redemption mechanisms.
The UST stablecoin and the native token LUNA are the two main components of the ecosystem. To mint UST, a person must just burn an equal number of LUNA. The user, on the other hand, can redeem their UST by trading $1 of LUNA.
Arbitrageurs potentially reap the benefits of this scenario by burning LUNA when the stablecoin is trading above the peg, or redeeming UST when LUNA is trading below $1, since the stablecoin is not absolutely pegged at $1.
LUNA and DAI Have Significant Differences.
- There is no hard collateral backing UST. The Terra ecosystem bought reserves in the form of BTC, AVAX, and other cryptocurrencies to try to absorb volatility if it became necessary.
- The UST peg is primarily influenced by LUNA market demand.
- Terra’s ecosystem is based on faith. Everyone within the ecosystem wants to think the other person or fund would not sell or redeem their UST. If more and more people do, LUNA’s value will fall dramatically, causing it to hyperinflate and quickly approach $0.This is referred to as a “death spiral”
De-pegging of TerraUSD → Downturn
7– 8 May 2022 — Initial De-Peg
The UST peg was being tested for the first time at this point. In the 3-Curve pool, $85 million flew from UST to USDC. Curve pools are a type of DeFi exchange that is used to keep the peg stability of assets like stablecoins.
As slight fluctuations on stablecoins don’t really make headlines, users are in different parts of the world, and maybe continuing to work their normal jobs, retail investors would not have known at this point.
Funds with a big stake in the ecosystem, on the other hand, would pay special attention. As previously stated, when one big entity begins to sell, it creates a negative feedback loop of panic selling among the ecosystem’s other holders.
LFG (Luna Foundation Guard) publicly stated on May 8, 2022, that it would utilise $1.5 billion of its reserves (50 percent of BTC to market makers, 50 percent of UST to buyback BTC upon stability)
The Anchor Protocol reports $2.9 billion in outflows and a 20% drop in deposits during this time.
Day 1: The selling pressure has begun, and it is clear that many holders are selling and heading for the exits.
9th May 2022: Second De-Peg
The de-pegging process continued, with the prices falling to $0.60 at one point. Remember that the stablecoin’s goal is to keep its value at $1.
If you glance at the market capitalizations, you’ll discover that LUNA was around $25 billion at the time, while UST was around $19 billion. This meant that not all holders of USTs would’ve been able to exit.
The system’s confidence had been shaken, and the price of LUNA continued to plummet at an alarming rate.
After day two, LUNA fell 48 percent from $60 to $31, with much more selling taking place and UST holders escaping.
10–12 May 2022: Downturn
As said earlier, the ecosystem is largely based on faith. Although the peg was recovered to above $0.90 after the confidence was shaken, the ecosystem had been damaged.
The UST continued to de-peg to $0.2 over the course of the day and is now worth a few cents. With all liquidity dried up, the Anchor protocol and curve pools were no longer able to rescue them.
As an outcome, the one and the only way for people to prevent losing everything was to use the ecosystem’s mint-redemption mechanism, which meant selling their UST.
As a result, the LUNA token experienced hyperinflation, with the price dropping 99 percent from $31 to $0.01.
More than $41 billion in market capitalization was lost in just three days. Although the crypto industry has seen the death of prior stablecoins, the speed with which the ecosystem vanished was unexpected.
Reminder: All cryptocurrency is risky, so do your homework before actually investing in these projects. Make wise decisions, because we’re all in this for the long term.