Death Spiral For Luna and Ust: Is It All Over? Or is it a New Start?

By ☑️0🆇D̺͈͙͕̿ͧ̑ͣ🅰🆅🅸🅳eͤ | Darknet | 15 May 2022

The dreaded "Death Spiral" struck Luna, causing her to drift. The protocol was attacked 5 days ago by manipulating the price of its stable algorithmic Ust, creating the depeg. This led to the infamous "Bank Run", ie the flight of capital (decrease in liquidity). The Ust depeg had already taken place in December 2020 and May 2021 due to the high volatility of the markets. The Terra ecosystem, the second largest in the Defi, with over $ 30 billion has been completely emptied. Today it is easy to see the downsides and uncover the flaws. There had been some red flags in the months: Anchor's APY had flooded the ecosystem with liquidity. Many platforms on Terra used lockdrops with Ust, to launch their tokens (just think of Astroport, Retrograde and Mars Protocol). All this allowed Ust and Luna to continuously increase liquidity (this was essential for maintaining Ust's peg). The sudden outflows of capital, due to the Bear Market or a possible exhaustion of the Anchor yield reserve, could have led to the much feared bank run but in reality what happened was an attack. I had huge losses because I was staking on chain by Luna and was also exposed on Anchor with Ust. I also used some lockdrops with Ust blocked for 1 year (Astroport and Mars Protocol). I managed to liquidate my Ust by selling them for $ 0.40. However, it is now too easy to talk about Ponzi or a poorly constructed system.

I remember that Ust maintained the peg by means of arbitrage incentives (seigniorage): 1 Ust minted, burned 1 dollar of the Luna and the destruction of 1 Ust creates 1 dollar of the Luna.

The founder of Terra, through the foundation, had bought several billion dollars worth of Bitcoin to make the Ust peg more stable. The peg's defense system should have worked like this:

1) Depeg down: with 1 Ust you can always redeem 0.98 dollars of Bitcoin so if 1 Ust drops to 97 cents or below, I redeem and buy 0.98 dollars of Bitcoin spot (this is convenient because Ust is worth 0.97 dollars dollars yet I get 0.98 dollars worth of Bitcoin, as if I bought it at a discount)
2) Depeg upwards: in this case 1 Ust is always worth 1 dollar of Bitcoin so if 1 Ust exceeds 1 dollar (for example it reaches 1.03) it is better to exchange 1 dollar of Bitcoin for 1 Ust and then sell at the Ust spot market

This peg defense system was designed precisely because Bitcoin, being less volatile than the Luna, would have held up better the Bear Market. If Luna falls too fast, arbitrage would not have been convenient and Ust would have lost the peg. How did the attack happen?

- 100,0000 Btc (about $ 3 billion dollars) was borrowed
- they dumped part of the bitcoins they borrowed on the market, to cause panic
- they spread FUD on the peg and the bank run (about 4 billion dollars had been withdrawn from Anchor during the night, TVL dropped from 20 billion to 16 billion in a few hours)
- later all the liquidity from Curve was eliminated (350M Ust was enough to do so), when Terra decided to move them to 4pool (Usdc / Usdt / Ust / Fax). With less liquidity, it is easier to manipulate the price
- then they started dump their Ust on Curve and Binance, creating a $ 0.97 depeg (Ust flooded the market, due to sales)
- they opened short positions on the Ust and on Btc
- capital flight triggered an ever larger depeg with less profitable arbitrage due to an ever larger spread
- the scheme was: to remove liquidity and dump Ust, remove liquidity again and dump Ust and so on. Eventually the Curve pool found itself unbalanced with only Ust. The first loss of the peg occurred only on Ust Erc20

- the Terra market module was configured for a daily throughput of $ 150M, for the recovery of the peg it would have been sufficient if the liquidity on Curve had been as expected
- panic unleashed because Btc was going down and because of the depeg danger of Ust, Luna Foundation Guard started selling Btc to restore peg
- the attackers shorted Btc
- Terra sells BTC, while attackers put even more pressure by dumping Ust
- the more BTC they sold, the more BTC collapsed and the panic increased accordingly
- congestion paralyzed the chain, limiting arbitrage, exchanges suspended withdrawals until the bank run
- Luna Foundation Guard probably understands what was going on and stops dumping Btc
- then they try to restore the peg, through the market module
- Luna collapses: sales due to lack of confidence but also due to sales on Ust and liquidations on Anchor (due to the collapse of Luna itself) and the inability to increase one's collateral due to network congestion

- all of this would not have been economically feasible if 4pool had been active because emptying the 4pool alone would have required $ 3 billion instead of $ 350 million (cash was drained easily)

The attack would have yielded a profit of around 1 billion dollars. What happened next? The sell-off of Ust led to the flood of Luna's supply which began to drop sharply and quickly. The protocol has decided through DAO to triple Luna's supply input, practically zeroing the price and to burn several billion US dollars to incentivize arbitrage again.
In the future, Ust could be collateralized if it survives. The Gemini exchange would have been accused of having granted the loan to the attackers (according to rumors they were Citadel Securities and Blackrock).
Given the great dilution of supply and the very high emission rates, it is absolutely not recommended to invest, trade and use liquidity pools with Luna as protagonist. Luna has also been delisted from Crypto.com, FTX, Kucoin and major exchanges.
There were also rumors of 8 suicides due to the crash with people losing everything, in reality the news would have been denied. Obviously all the TVL of Terra has emptied itself with all the protocols emptied. Not only Anchor but also Mirror, Astroport, Mars Protocol, Edge Protocol, Terraswap, Nexus Protocol, Pylon, etc A real meltdown.

One note that can be made and one lesson that can be learned from this whole story is that over-the-top marketing isn't always a good thing. The exasperated marketing had skyrocketed Luna's price and Anchor's TVL to dominate DeFi (due to its stellar 19.50% on Ust), similarly proved fatal as it approached many people who didn't know how the protocol worked. These people, unknowingly, threw fuel on the fire by encouraging the dump in turn, panicking and unleashing the bank run. The founder Do Kwon himself had made many enemies with not exactly flattering tweets such as the following:
In another interview about ten days ago, he had indirectly anticipated his own demise, stating that 95% of the altcoins would die and that he would have enjoyed seeing their demise.
Coindesk, in an article a few days ago, reported that Do Kwon had taken part in another project (which later failed) on an algorithmic stable called Basis Cash (in that case he had used the pseudonym of Rick Sanchez) which then collapsed to $ 0.01 in January 2021.
In the last few hours, an individual would have broken into Do Kwon's home, to the point of prompting his wife to seek help and protection from the police.
Usdn, another algorithmic stablecoin of the Waves ecosystem, also lost the peg by derailing on 70 cents. Another similar stablecoin that uses Luna's mechanism is Usdd (Tron is used instead of Luna). I remember that stablecoins such as Usdc, Usdt, Busd are collateralized by real dollars so even if they lose the peg there would be no problems. Mim, Dai and Musd from other assets. The European commission following this bad story announced that they will try to regulate stablecoins.

WHAT FUTURE FOR TERRA?
Due to the dangerous situation why Anchor hasn't blocked withdrawals? It would have been a big responsibility but he probably would have avoided the bank run.
The chain on the day of May 12 was arrested at block 7603700 to prevent any attacks on governance, due to the lack of power of the validators due to the very high supply of Luna.
Kujira (platform where it was possible to become liquidators on Anchor) will move to Cosmos. Meanwhile, some platforms with lockdrops in progress (Astroport, Mars Protocol, Retrograde, Pylon Gateway, etc) have proposed in the various governance structures to immediately unlock the Ust, removing the months of blocking for users.

During the night, rumors began to circulate of an organization in the chain with the birth of a new Luna with snapshots taken before the attack. Could it be a new beginning for Luna? Who will trust? Here for more info: Terra Ecosystem Revival Plan