The Biggest Collapse in Crypto History: The Fall of UST LUNA
During May 2022, the world witnessed the collapse of what was then the 3rd largest stablecoin by market cap — UST
Overview of the Terra Luna Ecosystem and UST
UST is the algorithmic stablecoin within the Terra ecosystem, and as a stablecoin it is meant to maintain a $1 to $1 peg through its mint and redemption mechanism.
Within the ecosystem, you essentially have the stablecoin which is UST and the native token LUNA. For a user to mint UST, they simply burn an equal amount of LUNA. On the other hand, to redeem their UST, the user can do that by exchanging $1 of LUNA. Due to the fact that the stablecoin is not perfectly pegged at $1 and it is meant to fluctuate a little bit above and below the $1 peg, arbitrageurs can take advantage of this scenario by either burning LUNA when the stablecoin is trading above the peg, or redeeming UST when LUNA is trading below $1.
Major differences between LUNA and DAI
- UST is not backed by hard collateral. The Terra ecosystem purchased reserves in the form of BTC, AVAX and others to try and absorb volatility if needed
- UST’s peg depends heavily on market demand for LUNA
- Terra ecosystem is faith based. Everyone in the ecosystem is believing that the other individual or fund won’t sell/redeem their UST. If enough people do, then LUNA will lose significant value, causing LUNA to hyperinflate and rapidly approach $0. This is what happened through early May 2022, and is also known as a “death spiral”
De-pegging of UST →Death Spiral
May 7–8, 2022 — First De-Peg
This was the first sight of the UST peg starting to be tested. $85 million was swapped from UST to USDC in the 3-Curve pool. Curve pools are a DeFi exchange utilized for assets like stablecoins to keep their peg stability. At this point, retail investors would not have known because minor fluctuations are not making headlines on stablecoins, people are in different time zones, and could be working their day jobs. However, the funds who have a large stake in the ecosystem would be paying close attention. Like we mentioned before, when one large entity starts selling, their creates a negative loop of selling pressure amongst other holders in the ecosystem. The funds would want to minimize their losses, therefore pay close attention when de-pegging events start to alert them.
- On May 8th, 2022, LFG (Luna Foundation Guard) announced they would deploy $1.5 billion of its reserves (50% of BTC to market makers, 50% of UST to buyback BTC upon stability)
- During this time, the Anchor Protocol say close to $2.9 billion in outflows, and deposits dropping over 20%
After day 1: Selling pressure has been started and its evident that many holders are selling and heading for the doors.
May 9th, 2022–Second De-Peg
The de-pegging continued with the price dropping to as low at $0.60 at one point. Remember, the aim of the stablecoin is for its value hold to $1. If you look at the market cap, you would’ve noticed that LUNA had a market cap at the time of about $25 billion, while UST was roughly at $19 billion. This meant that, not all UST holders would be able to exit.
The confidence of the system had been shocked and the price of LUNA continue to dropped at a dramatic pace.
After day 2: LUNA dropped 48% from $60 to $31, with more selling happening and UST holders heading for the exit.
May 10–12th, 2022 — Death Spiral
Like we mentioned above, the ecosystem is essentially run on faith. With the confidence shook, even though the peg was restored back to above $0.90, the ecosystem had been broken.
As the days went on, the UST continued to de-peg down to $0.2 and is now sitting at the value of a few cents. The Anchor protocol and the curve pools could no longer save them anymore, with all liquidity being dried up. As a result, the only way for people to not lose everything was to go through the mint-redemption mechanism of the ecosystem, meaning sell your UST. Consequently, this drove hyperinflation into the LUNA token, causing the price of LUNA to drop 99% from $31 to $0.01.
Conclusion: Over $41 billion in market cap was erased in about 3 days time. Although the crypt industry has witnessed the death of previous stablecoins before, the pace at which the ecosystem disappeared was catastrophic and something that has not been seen before.
Reminder: All of crypto is risky so please do your own research when investing into these types of projects. Make smart decisions, as we are all here for the long-haul.
