Luna cryptocurrency falters as Terra USD volatility continues

  • LFG has rolled out its BTC reserves, but $1 billion of circulating supply contraction has so far failed to re-establish the dollar peg, with UST trading around 90 cents
  • Critics have long worried about the viability of an undercollateralized stablecoin

Retail users who relied on Terra’s anchor protocol as a safe, high-yield savings account are waking up to an unpleasant new reality.

Terra USD (UST) has been trading well below its dollar peg since Saturday, but the initial drop to 98 cents turned out to be the prelude to a much bigger drop. It even caught the attention of US Treasury Secretary Janet Yellen, who cited the UST by name in congressional testimony today.

As Do Kwon’s Terraform Labs and the Luna Foundation Guard work to restore regular programming, the question arises for all: can the project be saved? And how?

The once-stable coin has slipped to just under 70 cents at some point in the past 24 hours, according to CoinGecko. This prolonged unanchoring led to massive withdrawals from the preeminent Terra dApp Anchor blockchain, which saw its deposits plummet by some $7.8 billion.

The net contraction in UST supply is already around $1 billion. As each UST is traded for $1 of LUNA, the supply of the latter increases. Since the unrest began on May 7, approximately 25 million LUNAs have been struck by the protocol.

The increase in supply has decimated the price of Terra’s native asset, which has fallen 64% over the past week, according to data compiled by Blockworks.

On Tuesday, Terra mastermind Do Kwon again sought to assuage concerns via Twitter, postulating an imminent – albeit unspecified – stimulus package.

monday madness

After dropping to 92 cents at 2:30 p.m. ET on Monday, the UST appeared to stabilize over the next few hours, but conditions quickly deteriorated from around 6:15 p.m. as the UST began a slide ceaseless two hours towards a nadir of about 65 cents.

Unlike the price action over the weekend, which centered on UST trading via centralized exchanges and the Ethereum dex curve, the extreme volatility this time caused the UST to fall on the Terra Channel itself. The speed of the descent exceeded the planned arbitrage-based stabilization mechanism built into the design of the protocol, which has a soft cap of around $290 million per day for $1 redemptions.

Exceed the cap and the gap – the amount of LUNA a UST can be traded for – is designed to widen. The concept is supposed to prevent manipulation of the mechanism, but it also makes it a slow job of recovering from such a violent shock.

Algorithmic stablecoins remain highly experimental and have failed spectacularly before. More recently, the Waves-based stablecoin USDN crashed to 77 cents in early April and never fully recovered. It used a burn-and-mint stabilization mechanism roughly similar to that of the UST, and the platform’s WAVES token has since dropped 80%.

UST itself suffered a similar volatility-induced crash in May 2021, when it briefly hit 96 cents. But on a one-year chart, it now appears as a small bump in the road.

UST over the past year; Source: CoinGecko

Many members of the Luna community, who call themselves “crazy”, have expressed support for the protocol and its supports, even in difficult times. But for some, whether or not the ankle recovered, it was a catastrophic loss.

The instability is no shock to crypto veterans, according to Mark Richardson, head of research at Bancor, a decentralized exchange and liquidity protocol.

“If you ask anyone in the industry if this is a surprise or not, everyone will tell you they’re surprised it didn’t happen sooner,” Richardson told Blockworks.

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  • Macauley Peterson

    Macauley was an editor and content creator in the professional chess world for 14 years, before joining Blockworks. At Bucerius Law School (Masters in Law and Commerce, 2020), he researched stablecoins, decentralized finance, and central bank digital currencies. He also holds a master’s degree in film studies; the film’s credits include associate producer of the 2016 Netflix feature-length documentary, “Magnus” about world chess champion Magnus Carlsen. He is based in Germany. Contact Macauley by email at [email protected]

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