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The cryptocurrency Terra LUNA made headlines back in April 2022 for touching a record high of almost $119 per unit. However, just within a month, the price had fallen to almost zero. The two coins, Terra LUNA and Terra UST are currently much talked about within the crypto space, and many in the industry are regarding the LUNA/UST fiasco as one of the most terrible crypto crashes ever.
The fact that UST had grown into the third-biggest stablecoin and LUNA was among the best-performing crypto assets before the crash makes the whole thing even more unfortunate. But what caused the LUNA/UST disaster? Let’s find out.
What Happened with UST and LUNA?
The Terra blockchain facilitates the UST (TerraUSD) stablecoin, which is powered by the LUNA token. Due to the de-pegging of UST, LUNA is currently experiencing extreme volatility, and the validators on the Terra blockchain have halted it indefinitely. Meanwhile, UST has remained de-pegged from the US Dollar since May 9, 2022.
UST Price History for the Last Three Months
Source: CoinmarketCap
UST, which was programmed to maintain its USD peg at a ratio of 1:1, is trading at around $0.017 as of the first week of June, placing both itself and LUNA into what is being called a death spiral. Since its all-time high in April, LUNA lost over $41 billion in value in just over a month.
LUNA Price History in the Last Three Months
Source: CoinmarketCap
To understand what exactly went wrong with TerraUSD and LUNA, we first have to know the roles the two tokens play on the Terra blockchain and the relationship between the two.
What Roles do LUNA and UST Play on the Terra Blockchain?
The LUNA tokens were used for functions like staking and mining stablecoins like TerraUSD on the Terra blockchain.
On the other hand, UST was a stablecoin that was programmed to be created when an equivalent number of LUNA tokens were burned. UST is not pegged to real-world assets like the USD, unlike the stablecoins like USDT or USDC. So the LUNA token was TerraUSD’s underlying asset, acting as collateral for the stablecoin and working to maintain the stability of the UST.
UST was programmed to regulate, maintain, and control its value in correspondence to LUNA. The stablecoin maintained the stability of value by keeping a 1:1 mint and burn ratio with the LUNA token.
As you can fathom, this whole system made UST completely dependent on the market demand for the LUNA coin. This dependence is what made both LUNA and UST susceptible to a death spiral in the first place, where both of the tokens lose value once the broader market loses its confidence in them and redeems TerraUSD for LUNA in massive volumes.
What Brought About the De-Pegging of UST?
As mentioned before, the TerraUSD has been de-pegged from the USD since May 9, 2022. How did this happen? Well, UST’s peg was first brought under stress when an $85 million exchange did a pool back on May 7. This made the pool’s liquidity providers lose confidence and withdraw some of the assets they had lent out. This is when UST first started losing its value.
On May 8, the LFG, or the Luna Foundation Guard, announced that it would deploy $1.5 billion of its reserves and would loan $750 million of BTC to market makers to be sold and defend UST’s peg. Further, they pledged another $750 million of UST to buy back the BTC once the volatility settles down.
Unfortunately, by then, more than $2.86 billion had been removed from the Anchor Protocol, which is a Terra lending platform that gives out a yield of up to 20% to TerraUSD depositors. With this event, UST’s peg continued to break down; prices fell further. With more and more liquidity providers leaving the market with whatever they could take then left people with only one way to exit: by redeeming LUNA for TerraUSD and therefore minting a huge amount of LUNA.
The circulating supply of LUNA tokens at the moment thus went from 386 million to 32 billion in only about 48 hours, the rate of hyperinflation being 8190%. TerraUSD de-pegged heavily as the price of LUNA too suddenly dropped to $0.01. The death spiral led to the halting of the Terra blockchain as we know it.
The LUNA/UST fiasco showed how the UST stablecoin model was actually pretty centralized because of its dependence on the LUNA token’s value, despite its claims of being a decentralized medium of exchange. As per crypto experts, this crisis may further spread the extent of the current majorly bearish sentiments in the wider crypto markets.
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
