The cryptocurrency market is plummeting. The economic situation, inflation, and the recent interest rate hike in the US have caused widespread falls not only in the stock market but also in cryptocurrencies that are seeing drops of 80-90% compared to the highs they reached just a few months ago. The falls have been precipitous, and analysts point to a big culprit: the Terra ecosystem’s UST and LUNA cryptocurrencies, which some have already dubbed as the ones responsible for the ‘Lehman Brothers moment’ of crypto. Let’s see what it’s all about.
What is Terra? It is an ecosystem with a blockchain, as is bitcoin (with its token BTC) or Ethereum (with the ETHs). In this case, Terra is designed to issue algorithmic stablecoins. There are several associated with the platform, although the best known is Terra USD (UST).
These algorithmic stablecoins are backed by the native token of this ecosystem, which is called LUNA and is not stable, as we will see below. The Terra network is based on a PoS consensus algorithm, and investors can do stacking through a decentralized application called Terra Station.
Stablecoins have a purpose. Those algorithmic stablecoins in the Terra ecosystem are linked (‘pegged’) to traditional fiat currencies, especially the dollar, and the algorithms promise to maintain that 1:1 parity that essentially makes for the vast majority of their existence, 1 UST = 1 dollar. Variations have been minimal, and with that investors had a recourse to stay within the cryptocurrency segment and switch from any cryptocurrency to UST and then use those USTs to buy other cryptocurrencies as if they were using dollars.
What LUNA was good for. Unlike the stablecoins issued on the Terra platform, LUNA is not a stablecoin, it is a conventional token, but important because it serves to support and stabilize that link or ‘peg’ of UST and the rest of the stablecoins issued by Terra.
As Fernando Gutierrez explained in a Twitter thread, LUNA is the mechanism that facilitated backing and trading UST. The demand and supply of UST were regulated by the price of LUNA, which went up if the supply of UST was reduced and went down if the opposite happened and the demand went down. Theoretically, if there was a deviation from the link, the process could be arbitraged by buying or selling LUNA.
Things got messy. Some changes in the UST issuance meant that when someone paid with LUNA to buy UST, those tokens were not “burned/destroyed”: a part was kept and those funds were used to buy bitcoin. The bitcoin reserve was managed by the Luna Foundation Guard (LFG), an NGO dedicated to guaranteeing the UST link and the correspondence 1 UST = 1 dollar.
A protocol called Anchor offered almost 20% if you deposited UST: it was a complex investment that generated very high demand and helped LUNA to rise sharply in value: at the beginning of May, it exceeded 116 dollars. The managers of the protocol announced that to guarantee its sustainability, they were reducing the interest rate to around 15%, which reduced the demand for USTs. Consequence: pressure on the price of LUNA.
LUNA loses 100% of its value and has been delisted on Binance. All this was compounded by the economic situation and the fall of cryptocurrencies, which also affected LUNA and UST, whose link was broken (‘depeg’). Some argue that this is due to an attack by a large investor, but this is not confirmed. What is certain is that a dollar was no longer a UST: the value fell as people started selling en masse. The LFG used its bitcoin reserve to buy UST on the market and reduce the pressure: it sold $1.5 billion in bitcoin and that further aggravated the fall of this and the rest of the cryptocurrencies.
UST recovered some ground and then lost it again, and is now at $0.00 when we repeat, it had never moved from the $0.99-1.01 range. The future does not look good although there seems to attempt to rescue UST and LUNA, which from being worth almost $118 a month ago is now worth just 0.0000000000000000226194. Meanwhile, on the LUNA subreddit, they have left suicide hotline numbers pinned to the top because of the huge losses this is generating for many people.
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