BREAKING: Terra Stablecoin Depegs in Historic Collapse

By Zacharias | RekTimes | 11 May 2022

11 May 2022: In what will be known as one of the most historical, dark days in the entire cryptocurrency space, Terra’s stablecoin UST and complementary LUNA token have completely collapsed after UST depegged.

UST is a dollar-pegged stablecoin that completely lost its peg multiple times within the past two days, now collapsing to under 0.50 cents as LUNA has fallen nearly 90% in 24 hours to under $3 per token.

Both UST and LUNA were previously top 10 cryptocurrency projects apart of a $40 billion ecosytem

The Breakdown

UST is what has been considered an algorithmic stablecoin, leveraging arbitrage to maintain the peg. For example, LUNA could always be redeemed for UST and vice versa. If UST fell below $1, LUNA could be exchanged and burned $1:$1 for UST.

Additionally, UST was utilizing Anchor protocol for utility as most of UST’s circulating supply could be found in Anchor. The incentives here were the massive 20% APY being offered on UST. How was this possible to maintain?

The Luna Foundation Guard (LFG) were using Terra’s ecosystem fund to artificially inject liquidity into Anchor to maintain that 20%. This is, broadly, where the death spiral scenario came to play.

How UST Failed

The 20% Anchor APY was always going to be unsustainable. LFG was simply betting that with more UST burned for staking, the price of LUNA would appreciate and allow LFG to sell-off more LUNA to fund the reserves. This would be possible until either LFG runs out of funds to maintain the APY or UST is fully adopted.

After a previous depegging event that put immense pressure on UST, Terra formed a $1 billion Bitcoin to essentially reinforce the reserves and give the Terra ecosystem an offramp into Bitcoin. This worked relatively well until the market began declining into heavy selling pressure.

With LUNA falling rapidly in price, redeeming UST for LUNA absolutely flooded the market with additional LUNA tokens, further pushing the price down and dragging down the peg. Bitcoin at this time was also falling in price.

Collapse of LUNA token

Depegging of UST

This created a negative feedback loop than the positive bet LFG was making. UST was being sold off, creating downward pressure on the price. UST could be redeemed for LUNA and then the LUNA was dumped. Further selling pressure, further incentives to dump UST, and the loop continues. This is the death spiral.

After LFG unloaded all of their Bitcoin collateral and failed to correct the peg, there was nothing left to reverse the loop and the peg has since completely collapsed as everyone rushed for the exit.

The Fallout

Terra’s UST was long touted as the very first - and only - decentralized stablecoin to exist, serving as a direct counter to stables such as USDT or USDC. The problem is, with Terra being heavily backed by venture capitalists and institutional investors, as soon as instability became prevalent, it triggered a bank run.

This wasn’t just a moon coin - this was effectively the savings of many individuals within the cryptocurrency space, hoping to utilize UST as a crypto-backed stablecoin.

Though at the time of this write up both coins still maintain value, the trust in the stablecoin aspect of UST will forever be severed.

Summary

The failure of UST is a tragedy in the space as, historically, it is the most significant collapse of a cryptocurrency asset ever. UST was the third largest stablecoin in the space and both coins were top 10 by market cap.

In other words, a $40 billion ecosystem has been essentially erased.

Speculations have already begun stirring about the coming possibilities of harsh regulations dropped on the cryptocurrency industry and, more specifically, stablecoins themselves. What comes next is unknown, though the collapse of Terra will undoubtedly go down as a major crossroads in the cryptoeconomy.

We would like to extend our thoughts out to all of those that were impacted by this collapse.