Luna Crypto Crash: How UST Failed, Why it Matters and What’s next

16 min read

The market for cryptocurrency isn’t looking good currently. All over the place Bitcoin and ether are both at their lowest since the year 2000, while altcoins such as dogecoin as well as Cardano are even worse off.

Although it’s a pity to crypto-investors, the decline isn’t unheard of. Cryptocurrencies are known for their volatility and turbulence, and the current economic conditions are impacting not only cryptocurrency but also the stock market as well.

What’s unique, however, is truly remarkable is the demise of the Luna cryptocurrency as well as its associated stablecoin called terra USD, or UST. You might not have ever heard of UST previously, or have any idea what is a stablecoin is however it’s a huge deal. Millions of dollars of crypto assets have evaporated and sent shockwaves through the market.

There are two stories intertwined that are being told: the story of the UST stablecoin, and the one of the Luna stablecoin, both of which are part of the Terra blockchain. The UST coin was created to have its $1 value every day, but it was de-pegged on Monday, May 9, and has since dropped to 17 cents. There’s also Luna, which is the mainstay of the Terra ecosystem. Its value has plummeted into one of the more dramatic crypto crashes recorded.

The price of the coin dropped from $116 in April to 1 cent on Thursday. It’s dropped even more and is trading on the weekend at a fraction of a cent. As of this writing of this article, Luna has fallen to one-eighth of one cent. This kind of collapse was seen with small-cap meme coins before however, never for anything like Luna, which boasted a market capitalization of more than $40 billion as of this month.

“This is historic for the crypto markets,” said Mike Boroughs, co-founder of cryptocurrency investment company Fortis Digital. “This is a defining moment for the space due to its size and impact in terms of the number of people that lost substantial value.”
Luna Crypto Crash: How UST Failed, Why it Matters and What’s next

The market for cryptocurrency isn’t looking good currently. All over the place Bitcoin and ether are both at their lowest since the year 2000, while altcoins such as dogecoin as well as Cardano are even worse off. Although it’s a pity to crypto-investors, the decline isn’t unheard of. Cryptocurrencies are known for their volatility and turbulence, and the current economic conditions are impacting not only cryptocurrency but also the stock market as well.

What’s unique, However, what is truly remarkable is the demise of the luna cryptocurrency as well as its associated stablecoin called terraUSD, or UST. You might not have ever heard of UST previously, or have any idea what is a stablecoin is however it’s a huge deal. Millions of dollars of crypto assets have evaporated and sent shockwaves through the market.

There are two stories intertwined that are being told: the story of UST stablecoin, and the one of the luna stablecoin, both which are part of the Terra blockchain. The UST coin was created to have its $1 value every day, but it was depegged on Monday on May 9, and has since dropped to 17 cents. There’s also luna, which is the mainstay of the Terra ecosystem. Its value has plummeted into one of the more dramatic crypto crashes recorded.

Luna’s price chart depicts a historic crash.
Dextools

The price of the coin dropped to $116 in April to 1 cent on Thursday. It’s dropped even more and is trading on the weekend at a fraction of a cent. As of this writing of this article, luna has fallen to one-eighth of one cent. This kind of collapse was seen with small-cap meme coins before however, never for anything like luna, which boasted a market capitalization of more than $40 billion as of this month.

“This is historic for the crypto markets,” said Mike Boroughs, co-founder of cryptocurrency investment company Fortis Digital. “This is a defining moment for the space due to its size and impact in terms of the number of people that lost substantial value.”

Here’s what you should be aware of.

What is stablecoin?

To fully comprehend the implications of the crypto crisis First, you must understand what a stablecoin is. It’s basically an e-currency that’s tied to a stable currency. The most popular of these coins is Tether and USDC which, like many stablecoins are also dependent on that of the US dollar. If you own 1,000 USDC tokens for instance they could anytime be exchanged for $1000.

Stablecoins are an integral component of “DeFi,” or decentralized finance. They are designed to provide methods for investors to protect themselves from the fluctuation of the market for cryptocurrency. Let’s say ether’s price is $2,000; the trader can exchange one the ether for 22,000 USDC tokens. If ether’s price drops tomorrow by 50% to just $1,000 then those 22,000 USDC tokens will be worth $2000 and could be exchanged for two tokens of ether. When investors sense a slowdown coming, they invest their money into stablecoins such as the tether coin, USDC along with, up to this week, the UST.

Stablecoins are also a method to borrow and loan cryptocurrency and lending, which makes them a fundamental technology in DeFi.

The difference between the terra/UST coin from the tether coin and USDC is an important way that it isn’t backed with the actual US dollars but instead is known as an algorithmic stablecoin or decentralized. The idea is that with some clever mechanisms, and billions of bitcoin reserves the dollar peg of the UST can be kept without needing to be secured by dollars.

“A decentralized stablecoin is the Holy Grail of DeFi,” declared Cyrus Younessi, former head of risk management at MakerDAO the company behind DAI stablecoin. The main selling point of bitcoin and Ethereum is that they are difficult for politicians, bureaucrats or central bankers to regulate however their drawback is their price volatility. “If you could take those assets, extract stability out of them and productize it, then that’s huge,” Younessi stated.

“But it’s not very viable.”

Terra Luna, Terra and UST What are they?

Terra is a cryptocurrency, similar to Ethereum as well as bitcoin. Although Ethereum’s blockchain is natively producing Ethereum tokens, terra natively produces luna. Prior to it being depegged, luna traded at the price of $85.

To make UST To create UST, you must burn the luna. For instance this week, you could exchange one token of luna in exchange for 85 UST (since luna was worth $85) However, the token was removed (“burned”) during the process. This deflationary procedure was intended to ensure that the growth of luna was sustained over time. If more people invest in UST the more money would be burned, which would make the remaining supplies of luna useful.

To convince traders to spend in the process of creating UST and UST, the creators presented an incredible 19.5 percent yield on the staking process that is basically crypto-related terminology to earn 19.5 percent interest on a loan using what they called”the Anchor Protocol. Instead of depositing your savings in the bank at a 0.06 percent yield, their idea is to then to UST which can earn up to 20% interest. Prior to depegging, more than 70% of the circulating supply, roughly $14 billion was placed under the scheme.

Here’s the trick to UST keeping its peg: 1. UST can be able to be traded for $1 of luna. If UST falls down to 99 cents investors could gain by buying a massive volume of UST and then exchanging it for luna, earning one cent for each token. This is achieved in two ways the purchase of UST will increase the price as well as UST being burned in the exchange process to luna reduce the amount of UST available.

There are also reserves. Terra co-founder Do Kwon created the Luna Foundation Guard which is a group with the mission to safeguard the peg. The LFG contained around $2.3 billion worth of bitcoin reserves. It plans to grow that to $10 billion in cryptocurrency and bitcoin. If UST fell below $1 Bitcoin reserve would go to auction, and UST purchased with the profits. If UST exceeds $1, the creators would then make a sale of UST until it returns at $1 with proceeds being used to purchase more bitcoin in order to increase the reserves.

The whole thing makes sense. However, UST at this moment is worth just 17 cents.

What happened?

The whole thing began on May 7, 2007. The value of more than $2 billion of UST was seized (taken from the Anchor Protocol), and hundreds of millions of it was sold immediately. It is unclear if this was due to a volatile time due to the increase in interest rates has had a significant impact on the price of cryptocurrency -or a more shrewd attack on Terra’s system is the subject of discussion.

The massive sales drove the price to the low of 91 cents. Traders attempted to take advantage of arbitrage by exchanging the equivalent of 90 cents in UST for 1 cent worth of luna however, an obstacle was spotted. A mere $100 million worth of UST could be burned to make luna every day.

Investors, already frightened in the current market gloominess and flocked to the opportunity to trade their UST when the stablecoin was unable to keep its peg. It fluctuated between 30 and 50 cents over the following week after the initial depeg. However, it has since fallen to an unbroken low of fewer than 20 cents. The market cap for the stock was estimated at $18 billion at the beginning of May and has now risen to $2 billion.

The situation is even worse for holders of luna. The value of tokens issued by luna is almost gone: after a peak of less than $120 in April, the value is now only a tiny fraction of a penny.

Concerning the possibility that this is an attack that is malicious. There have been rumors there was a possibility an individual was attempting to cut UST in order to gain by shorting bitcoin — or, betting on its price to go down. If potential attackers took large positions of UST and then re-staked it for $2 billion in one go the position could be depegged UST and that would mean Terra’s team had to sell a portion of its bitcoin reserves to be able to repeg its stablecoin. After investors realized that UST was no longer pegged, they’d then be quick to unstack and sell their UST and would need additional Bitcoin reserves to be sold. This would add more pressure to sell.

It’s still speculation. Younessi isn’t sure if the depeg was triggered by an intentional attack or not, however, they said that the blame lies with the crypto developers to design safer systems.

“Our job as DeFi builders is to build systems that are resistant [to exploits],” the man said. “That’s literally in the original 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 years ago, when working as a DeFi Analyst at Scalar Capital, Younessi declared Terra’s model “broken”.

“Terra could have grown to be 10 times as large” prior to the crash, he told CNET. “Better that we prick that bubble of unsustainable protocols sooner than later.”

Why is it important?

It is important for three reasons.

First, more than $15 billion worth of crypto has been lost to the luna and UST all by itself. There have been reports of self-harm from those who had the bulk of their savings backed by UST although they aren’t confirmed however, it’s evident that many people lost lots of money due to the collapse. The impact isn’t limited to the terra ecosystem Fortis Digital’s Boroughs report states. A lot of people who were exposed to the luna and UST could have sold significant portions of their cryptocurrency portfolios to recover some of the losses which would have dragged the entire market lower.

It also raises questions about the stability of other stablecoins. Also, UST was unusual in the sense that the coin was an algorithmic one, unlike the tether or USDC. But the security of these coins has been in doubt. New York’s attorney general the last year claimed that tether was being deceitful about the amount it actually had in dollars reserves.

Boroughs is concerned that should UST were attacked it is possible that similar attacks could be played against other teams.

“The question in our minds becomes, does what happened to UST spread to other stablecoins?” the man stated. “If big whales found a playbook here that works to attack UST, we worry they may reuse that playbook in other areas of the market.”

The last, and perhaps most importantly, the demise of UST has drawn the interest of powerful politicians as well as regulators. The Secretary of the Treasury Janet Yellen said on Tuesday that the de-pegging of UST “simply illustrates that this [stablecoins] is a rapidly growing product and there are rapidly growing risks.”

“One place we might see some [regulatory] movement is around stablecoins,” Securities and Exchange Commission member Hester Pierce said on Thursday.

What’s next for luna, and UST?

It’s been a tough week for Terra developers since UST was depegged on May 10. Some prominent figures have asked concerns about Terra’s bitcoin reserves and the Terra blockchain has failed to function on two occasions. In the meantime, Do Kwon, CEO of Terra Labs, says he has plans to restore the value of Luna and to repeg UST.

As mentioned above in the previous paragraph, it was noted that the Luna Foundation Guard had around $2.3 billion worth of bitcoin. If there was depegging, the reserves would be traded, and the liquidity being used to purchase UST back to $1. What’s the reason it didn’t work?

Some have wondered how the LFG actually utilized the funds. In the course of one day on the 9th of May, $1.6 billion in bitcoin was transferred from the LFG’s account to Gemini which is a crypto exchange. A further $875 million was transferred to a bank account at Binance the largest cryptocurrency exchange. The transaction cannot be traced back to the other hand, either Gemini or Binance.

The lack of transparency leaves many in confusion, for instance, Changpeng Zhao, the founder, and CEO of Binance. “Where is all the BTC that was supposed to be used as reserves?” the tweeter tweeted Saturday. “Shouldn’t those BTC be ALL used to buy back UST first?”

“We are currently working on documenting the use of the LFG BTC reserves during the de-pegging event,” Kwon tweeted on Saturday. “Please be patient with us as our teams are juggling multiple tasks at the same time.”

“I am heartbroken about the pain my invention has brought on all of you,” Kwon stated in an email.

Kwon’s declaration came one day after Terra’s blockchain was shut down, which meant transactions of all kinds could not be made in the meanwhile plans for “reconstituting” the ecosystem was in the process of being developed.

This past Friday Kwon suggested a remedy for Luna’s issues. He suggested that the Terra Labs CEO suggested forking the terra, which means creating a brand new blockchain. A snapshot of the current Luna, as well as UST holders, will be taken. 990 million Luna tokens would be distributed across the group, with the remaining 100 million to a “community pool to fund future developments.” It’s basically an attempt to restore the blockchain to the state it was in prior to de-pegging.

Some, including Zhao, are skeptical about whether the strategy will be successful.

Here’s what you should be aware of.

 What is stablecoin?

To fully comprehend the implications of the crypto crisis First, you must understand what a stablecoin is. It’s basically an e-currency that’s tied to a stable currency. The most popular of these coins is Tether and USDC which, like many stablecoins are also dependent on that of the US dollar. If you own 1,000 USDC tokens for instance they could anytime be exchanged for $1000.

Stablecoins are an integral component of “DeFi,” or decentralized finance. They are designed to provide methods for investors to protect themselves from the fluctuation of the market for cryptocurrency. Let’s say ether’s price is $2,000; the trader can exchange one the ether for 22,000 USDC tokens. If ether’s price drops tomorrow by 50% to just $1,000 then those 22,000 USDC tokens will be worth $2000 and could be exchanged for two tokens of ether. When investors sense a slowdown coming, they invest their money into stablecoins such as the tether coin, USDC along with, up to this week, the UST.

Stablecoins are also a method to borrow and loan cryptocurrency and lending, which makes them a fundamental technology in DeFi.

The difference between the terra/UST coin from the tether coin and USDC is an important way that it isn’t backed with the actual US dollars but instead is known as an algorithmic stablecoin or decentralized. The idea is that with some clever mechanisms, and billions of bitcoin reserves the dollar peg of the UST can be kept without needing to be secured by dollars.

“A decentralized stablecoin is the Holy Grail of DeFi,” declared Cyrus Younessi, former head of risk management at MakerDAO the company behind DAI stablecoin. The main selling point of bitcoin and Ethereum is that they are difficult for politicians, bureaucrats or central bankers to regulate however their drawback is their price volatility. “If you could take those assets, extract stability out of them and productize it, then that’s huge,” Younessi stated.

“But it’s not very viable.”

 Terra Luna, Terra and UST What are they?

Terra is a cryptocurrency, similar to Ethereum as well as bitcoin. Although Ethereum’s blockchain is natively producing Ethereum tokens, terra natively produces Luna. Prior to it being depegged, luna traded at the price of $85.

To make UST To create UST, you must burn the Luna. For instance this week, you could exchange one token of Luna in exchange for 85 UST (since Luna was worth $85) However, the token was removed (“burned”) during the process. This deflationary procedure was intended to ensure that the growth of Luna was sustained over time. If more people invest in UST the more money would be burned, which would make the remaining supplies of Luna useful.

To convince traders to spend in the process of creating UST and UST, the creators presented an incredible 19.5 percent yield on the staking process that is basically crypt-related terminology to earn 19.5 percent interest on a loan using what they called”the Anchor Protocol. Instead of depositing your savings in the bank at a 0.06 percent yield, their idea is to then to UST which can earn up to 20% interest. Prior to depegging, more than 70% of the circulating supply, roughly $14 billion was placed under the scheme.

Here’s the trick to UST keeping its peg: 1. UST can be able to be traded for $1 of Luna. If UST falls down to 99 cents investors could gain by buying a massive volume of UST and then exchanging it for Luna, earning one cent for each token. This is achieved in two ways the purchase of UST will increase the price as well as UST being burned in the exchange process to Luna reduce the amount of UST available.

There are also reserves. Terra co-founder Do Kwon created the Luna Foundation Guard which is a group with the mission to safeguard the peg. The LFG contained around $2.3 billion worth of bitcoin reserves. It plans to grow that to $10 billion in cryptocurrency and bitcoin. If UST fell below $1 Bitcoin reserve would go to auction, and UST purchased with the profits. If UST exceeds $1, the creators would then make a sale of UST until it returns at $1 with proceeds being used to purchase more bitcoin in order to increase the reserves.

The whole thing makes sense. However, UST at this moment is worth just 17 cents.

 What happened?

The whole thing began on May 7, 2007. The value of more than $2 billion of UST was seized (taken from the Anchor Protocol), and hundreds of millions of it was sold immediately. It is unclear if this was due to a volatile time due to the increase in interest rates has had a significant impact on the price of cryptocurrency -or a more shrewd attack on Terra’s system is the subject of discussion.

The massive sales drove the price to the low of 91 cents. Traders attempted to take advantage of arbitrage by exchanging the equivalent of 90 cents in UST for 1 cent worth of Luna however, an obstacle was spotted. A mere $100 million worth of UST could be burned to make Luna every day.

Investors, already frightened in the current market gloominess and flocked to the opportunity to trade their UST when the stablecoin was unable to keep its peg. It fluctuated between 30 and 50 cents over the following week after the initial depeg. However, it has since fallen to an unbroken low of fewer than 20 cents. The market cap for the stock was estimated at $18 billion at the beginning of May and has now risen to $2 billion.

The situation is even worse for holders of Luna. The value of tokens issued by Luna is almost gone: after a peak of less than $120 in April, the value is now only a tiny fraction of a penny.

Concerning the possibility that this is an attack that is malicious. There have been rumors there was a possibility an individual was attempting to cut UST in order to gain by shorting bitcoin — or, betting on its price to go down. If potential attackers took large positions of UST and then re-staked it for $2 billion in one go the position could be depegged UST and that would mean Terra’s team had to sell a portion of its bitcoin reserves to be able to repeg its stablecoin. After investors realized that UST was no longer pegged, they’d then be quick to unstack and sell their UST and would need additional Bitcoin reserves to be sold. This would add more pressure to sell.

It’s still speculation. Younessi isn’t sure if the depeg was triggered by an intentional attack or not, however, they said that the blame lies with the crypto developers to design safer systems.

“Our job as DeFi builders is to build systems that are resistant [to exploits],” the man said. “That’s literally in the original 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 years ago, when working as a DeFi Analyst at Scalar Capital, Younessi declared Terra’s model “broken”.

“Terra could have grown to be 10 times as large” prior to the crash, he told CNET. “Better that we prick that bubble of unsustainable protocols sooner than later.”

 Why is it important?

It is important for three reasons.

First, more than $15 billion worth of crypto has been lost to the Luna and UST all by itself. There have been reports of self-harm from those who had the bulk of their savings backed by UST although they aren’t confirmed however, it’s evident that many people lost lots of money due to the collapse. The impact isn’t limited to the terra ecosystem Fortis Digital’s Boroughs report states. A lot of people who were exposed to the Luna and UST could have sold significant portions of their cryptocurrency portfolios to recover some of the losses which would have dragged the entire market lower.

It also raises questions about the stability of other stablecoins. Also, UST was unusual in the sense that the coin was an algorithmic one, unlike the tether or USDC. But the security of these coins has been in doubt. New York’s attorney general the last year claimed that tether was being deceitful about the amount it actually had in dollars reserves.

Boroughs is concerned that should UST were attacked it is possible that similar attacks could be played against other teams.

“The question in our minds becomes, does what happened to UST spread to other stablecoins?” the man stated. “If big whales found a playbook here that works to attack UST, we worry they may reuse that playbook in other areas of the market.”

The last, and perhaps most importantly, the demise of UST has drawn the interest of powerful politicians as well as regulators. The Secretary of the Treasury Janet Yellen said on Tuesday that the de-pegging of UST “simply illustrates that this [stablecoins] is a rapidly growing product and there are rapidly growing risks.”

“One place we might see some [regulatory] movement is around stablecoins,” Securities and Exchange Commission member Hester Pierce said on Thursday.

 What’s next for Luna, and UST?

It’s been a tough week for Terra developers since UST was depegged on May 10. Some prominent figures have asked concerns about Terra’s bitcoin reserves and the Terra blockchain has failed to function on two occasions. In the meantime, Do Kwon, CEO of Terra Labs, says he has plans to restore the value of Luna and to repeg UST.

As mentioned above in the previous paragraph, it was noted that the Luna Foundation Guard had around $2.3 billion worth of bitcoin. If there was depegging, the reserves would be traded, and the liquidity being used to purchase UST back to $1. What’s the reason it didn’t work?

Some have wondered how the LFG actually utilized the funds. In the course of one day on the 9th of May, $1.6 billion in bitcoin was transferred from the LFG’s account to Gemini which is a crypto exchange. A further $875 million was transferred to a bank account at Binance the largest cryptocurrency exchange. The transaction cannot be traced back to the other hand, either Gemini or Binance.

The lack of transparency leaves many in confusion, for instance, Changpeng Zhao, the founder, and CEO of Binance. “Where is all the BTC that was supposed to be used as reserves?” the tweeter tweeted Saturday. “Shouldn’t those BTC be ALL used to buy back UST first?”

“We are currently working on documenting the use of the LFG BTC reserves during the de-pegging event,” Kwon tweeted on Saturday. “Please be patient with us as our teams are juggling multiple tasks at the same time.”

“I am heartbroken about the pain my invention has brought on all of you,” Kwon stated in an email.

Kwon’s declaration came one day after Terra’s blockchain was shut down, which meant transactions of all kinds could not be made in the meanwhile plans for “reconstituting” the ecosystem was in the process of being developed.

This past Friday Kwon suggested a remedy for Luna’s issues. He suggested that the Terra Labs CEO suggested forking the terra, which means creating a brand new blockchain. A snapshot of the current Luna, as well as UST holders, will be taken. 990 million Luna tokens would be distributed across the group, with the remaining 100 million to a “community pool to fund future developments.” It’s basically an attempt to restore the blockchain to the state it was in prior to de-pegging.

Some, including Zhao, are skeptical about whether the strategy will be successful.

Via this site  Luna Crypto Crash: How UST Failed, Why it Matters and What’s next

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