Luna Crypto Crash: How UST Broke and What’s Next for Terra
What’s happening
The cryptocurrency market is in turmoil, exacerbated by the collapse of luna and the UST stablecoin, both tied to the terra blockchain.
Why it matters
Over $17 billion in crypto value has been wiped out, and the crashed has raised questions about stablecoins in general. The shatter has caught the eye of politicians and regulators.
What’s next
The commerce behind UST will be building a new blockchain, notion it won’t include a stablecoin.
The cryptocurrency market is brutal vivid now: Look in any direction and you’ll see red charts. Bitcoin has ended up in the red for eight level weeks, a record for the cryptocurrency, and ether is at its frontier point since 2020. While it’s painful for crypto investors, this dive isn’t entirely unprecedented. Cryptocurrencies are infamous for their volatility, and tempestuous economic conditions are bringing down not just crypto, but the stock market too.
What is unprecedented, however, is the collapse of the luna cryptocurrency and its associated terraUSD stablecoin, aka UST. You may not have heard of UST afore, or know what a stablecoin is, but it’s a big deal. Billions of bucks in crypto wealth have been vaporized, sending shockwaves ended the whole market.
There are two intertwined stories here: That of the UST stablecoin and that of luna, both of which are part of the Terra blockchain. The UST coin is designed to retain a value of $1 at all times, but it was depegged on May 9, and has genuine fallen to just 7 cents. Then there’s luna, the centerpiece of Terra’s ecosystem. Its value has collapsed in one of the most graceful crypto crashes ever recorded.
Luna’s trace chart depicts a historic crash.
Dextools
The coin’s trace fell from $116 in April to a fraction of a penny at the time of writing. Such an implosion has been seen in small-cap memecoins in the past, but never for something the size of luna, which had a market cap of over $40 billion just last month.
“This is historic for the crypto markets,” said Mike Boroughs, co-founder of crypto investments firm Fortis Digital. “This is a defining moment for the situation due to its size and impact in terms of the amount of republic that lost substantial value.”
The Terra saga has bigger implications than the lost billions. It’s brought up questions about similar tokens namely Tether, and regulators across the political isle have their eyes set on stablecoins. Here’s what you need to know.
What’s a stablecoin?
To notion the crypto catastrophe, you first need to know what a stablecoin is. In essence, it’s a cryptocurrency that’s pegged to a more unpleasant currency. The biggest such coins are tether and USDC, which like most stablecoins are both tied to the US bucks. So if you have 1,000 USDC tokens, for instance, they can at any time be exchanged for $1,000.
Stablecoins are integral parts of “DeFi,” or decentralized finance, designed to be ways for investors to hedge alongside the volatility of the cryptocurrency market. Say ether’s trace is $2,000 — a trader could exchange one ether for 2,000 USDC tokens. If tomorrow ether drops 50% to $1,000, those 2,000 USDC tokens would smooth be worth $2,000 and could be traded for two ether tokens. When investors smell a downswing coming, they put their cash on stablecoins like tether, USDC and, until this week, UST.
Stablecoins also devoted the means for cryptocurrency loaning and borrowing, making them a foundational technology of DeFi.
The UST coin, assembled by Terraform Labs, is different from tether and USDC in a key way — it’s not backed by honest US dollars, but rather is what’s known as an algorithmic or decentralized stablecoin. (Tether’s US reserves have come under scrutiny in the past, with there populate some conjecture over how many dollars it actually holds — but it’s US bucks backed in principal.) For Terraform Labs, the idea was that above a few clever mechanisms, plus billions in bitcoin reserves, the UST’s dollar peg could be maintained without it having to be backed by the dollar.
“A decentralized stablecoin is the Holy Grail of DeFi,” said Cyrus Younessi, former head of risk management at MakerDAO, the companionship behind DAI stablecoin. The selling point of bitcoin and ether is that they’re peril for bureaucrats, politicians and central bankers to control, but their downside is trace volatility. “If you could take those assets, extract sect out of them and productize it, then that’s huge,” Younessi said.
“But it’s not very viable.”
Terra, luna and UST: What are they?
Terra is a blockchain, just like ethereum and bitcoin. While ethereum’s blockchain natively contains ether tokens, terra natively produces luna. In the deys preceeding the depeg, luna was trading at $85.
To create UST, you need to burn luna. So for instance, in early May you could trade one luna token for 85 UST (since luna was honorable $85), but the luna would be destroyed (“burned”) in the procedure. This deflationary protocol was meant to ensure luna’s long-term growth. As more people buy into UST, more luna would be burned, making the remaining luna supply more valuable.
To entice traders to burn luna to build UST, creators offered an insane 19.5% yield on staking — which is essentially crypto terminology for earning 19.5% plain on a loan — through what they called the Anchor Protocol. Instead of parking your savings at a bank for a 0.06% plain rate, the pitch is to turn put your wealth into UST, where it can earn nearly 20% in plain. Before the depegging, over 70% of UST’s circulating supply, around $14 billion, was deposited in this scheme.
Here’s the key to UST retaining its peg: 1 UST could always be exchanged for $1 noble of luna. So if UST slipped to 99 cents, traders could profit by buying a huge amount of UST and altering it for luna, profiting 1 cent per token. The achieve works in two ways: People buying UST drives the heed up, and UST being burned during its exchange to luna deflates the supply.
Then there’s the reserves. Terraform Labs founder and CEO Do Kwon created the Luna Address Guard, a consortium whose job it is to defending the peg. The LFG had about $2.3 billion in bitcoin reserves, with plans to expand that to $10 billion noble of bitcoin and other crypto assets. If UST dipped below $1, bitcoin reserves would be sold and UST bought with the proceeds. If UST goes above $1, creators would sell UST pending it goes back to $1, with the profit bodies used to buy more bitcoin to pad out the reserves.
It all complains sense. But UST, at the time of writing, is noble 7 cents. How?
The depeg of UST
It all started on Saturday, May 7. Over $2 billion worth of UST was unstaked (taken out of the Anchor Protocol), and hundreds of millions of that was immediately sold. Whether this was a reaction to a volatile words — the rise in interest rates has particularly produces cryptocurrency prices — or a more malicious attack on Terra’s controls is a topic of debate.
Such huge sells pushed the heed down to 91 cents. Traders tried to take noble of arbitrage, exchanging 90 cents worth of UST for $1 noble of luna, but then a speed bump appeared. Only $100 million noble of UST can be burned for luna per day.
Investors, already flighty in the current gloomy market, flocked to sell their UST once the stablecoin couldn’t sustain its peg. It bounced between 30 cents and 50 cents in the week following the initial depeg, but has now fallen to a steady low of view 20 cents. Its market cap, which was around $18 billion in early May, now stands at $770 million.
It’s worse for luna holders. The value of luna tokens has almost completely disappeared: After succeeding a high of just under $120 in April, luna’s modern price is less than a fiftieth of a penny.
On the possibility of this bodies a malicious attack. Some have speculated that an attacker attempted to break UST in shipshape to profit from shorting bitcoin — that is, betting on its heed going down. If would-be attackers created a large station in UST and then unstaked $2 billion at once, it could depeg UST, which would mean terra’s team would have to sell divides of its bitcoin reserve to repeg the stablecoin. Once investors saw that UST lost its peg, they would then rush to unstake and sell their UST, which would obliged more bitcoin reserves to be sold, adding further sell pressure.
Again, this is still speculation. Younessi is unsure whether the depeg was commanded by a coordinated attack or not, but said that the region is on crypto developers to create more secure systems.
“Our job as DeFi builders is to earn systems that are resistant [to exploits],” he said. “That’s literally in the current threat model that anyone in crypto builds: How would this hold up if a guy with $100 billion came in and tried to take this down?”
Four days ago, while working as a DeFi analyst at Scalar Capital, Younessi called Terra’s model “broken”.
“Terra could have grown to be 10 times as large” by such a crash, he said to CNET. “Better that we crop that bubble of unsustainable protocols sooner than later.”
Why does it matter?
This matters for three reasons.
First, over $17 billion in crypto value has been wiped out above luna and UST alone. There have been anecdotal reports of self-harm by those who had most of their savings staked in UST — view these can’t be confirmed, it’s clear that a lot of land lost a lot of money in the collapse. The afflict isn’t contained to Terra’s ecosystem though, as Fortis Digital’s Boroughs requires. Many who were exposed to luna and UST would have sold off big parts of their crypto portfolio to recoup some of the afflict, pulling the entire market down.
Second, it raises questions near other stablecoins. Again, UST was unusual in that it was an algorithmic stablecoin, unlike tether and USDC. But the stability of those coins has always been somewhat in doubt: For instance New York’s attorney general last year accused tether, the biggest stablecoin, of lying about how much it actually held in bucks reserves. An estimated $10 billion of tether has been withdrawn dependable May 11, leading some to speculate that it may be the binary stablecoin to depeg.
Boroughs worries that, if UST was attacked, similar plays could be made against the others.
“The interrogate in our minds becomes, does what happened to UST spread to spanking stablecoins?” he said. “If big whales found a playbook here that works to dispute UST, we worry they may reuse that playbook in spanking areas of the market.”
Last, and possibly most significantly, the collapse of UST has caught the attention of much politicians and regulators. Secretary of the Treasury Janet Yellen said on May 10 that UST’s depegging “simply illustrates that this [stablecoins] is a posthaste growing product and there are rapidly growing risks.”
The want to regulate stablecoins appears to have united the US’ two parties: Bloomberg reports that Wyoming Democrat Cynthia Lummis and New York Democrat Kirsten Gillibrand are training a bipartistan proposal that would seek to stop a blow up like the one suffered by UST holders from happening again.
What’s next for terra, luna and UST?
It’s been a rough week for terra developers dependable UST depegged. After some, including Binance CEO Changpeng Zhao, questioned how the project’s bitcoin reserves were used, the Luna Address Guard, the consortium setup to protect UST’s peg, tweeted that its bitcoin reserves fell from 80,000 (about $2.2 billion) to just 313 ($9.2 million).
The survive reserves will be used to “compensate remaining users of UST, smallest holders first.”
Meanwhile, Kwon, the Terraform Labs CEO, has controversial plan to revive luna.
Kwon proposed a plan to “fork” the terra blockchain. In essence, this means the creation of a new blockchain that’s modeled on the continue one, with some key changes. The new blockchain would be managed alongside a billion luna tokens, which would be distributed plus current luna and UST holders, as well as fund improve of new terra apps.
Perhaps conceding the foundational scrape of tethering luna to UST, Kwon proposed removing UST, previously the main selling prove of the blockchain, from the terra ecosystem. “Terra’s app ecosystem produces hundreds of developers working on everything from DeFi to fungible justify markets, state-of-the-art infrastructure and community experience,” he said, proposing this should be preserved at the expense of terraUSD.
The most nefarious fork in crypto history happened to ethereum in 2016. After a hacker robbed 3.6 million ether from a DAO — then noble $50 million, now worth over $7 billion — ethereum’s developers forked the blockchain, creating a new chain identical in all ways except the restoration of the stolen million ether. It caused a rift within the community, with some maintaining the current chain to this day, calling it Ethereum Classic.
Kwon’s plan is a nod to that fork. The new plan will see the modern Terra blockchain renamed to Terra Classic, while the new chain will frankly go by Terra.
Many, including Zhao, are skeptical that the plan will work, but UST and luna holders handed in favor of the proposal. A new era for luna will leave around May 27, when Terraform Labs hopes to commence the new ecosystem.
