Why did the UST drop stablecoin and what is the future of Terra ecosystem?

UST price fell almost 75%

In a few days, the UST ecosystem course Terra (LUNA) was a real nightmare. The stable broke away from the dollar and at first fell to $ 0.65before temporarily rising and falling back to a low point at $ 0.22, which shook the entire cryptocurrency industry.

Figure 1: UST price against the US dollar

It may seem surprising, even counter-intuitive, but stablecoins can indeed be break away from the currency which are supposed to be “peg”. At least some of them do. To understand this, one needs to understand the different categories of stablecoins.

Stables like USDT or USDC are pegged to the dollar price by being straight backed by a pool of tangible assets. Conversely, algorithmic stable bases, like the UST, depending on algorithm maintain their indexing to the dollar.

To put it simply, the UST course is maintained thanks to arbitration mechanism organized by users. Concretely, when the UST price falls, 1 UST can be exchanged for 1 LUNA dollar to reduce the total supply and increase its value to the equilibrium. The phenomenon also applies in the other direction.

However, this strategy is very risky. Where many UST would be sold in a very short time, the volumes would be so large that the arbitrage would not have time to react and reverse the trend. And that is precisely what happened.

👉 To dive deeper, our complete guide to TerraUSD (UST), a decentralized and algorithmic stable coin driven by LUNA

Concretely, why did the UST fall?

UST and LUNA, infernal spiral

In a few months, the UST managed to get to the third position of stablecoins most capitalized on the market. The main reason is Anchor, which has been engaged so far 52% of the total quantity in circulation, or $ 10 billion. And for good reason, the protocol provides a 19.5% annual return for the UST pledge.

As the reward was paid in UST, new coins were created daily. However, as explained above, The result of 1 minced UST is 1 dollar LUNA burned. In other words, it was under constant upward pressure, which saw a 10 per cent increase in their price.

You would understand it, everything is fine as long as the market remains bullish. But of course, this system has a colleague and we have experienced it for the past few days. At the end of last week, in the geopolitical context of weather and following the announcements of the American Federal Reserve, the cryptocurrency market came to an end.

Like all altcoins, LUNA follows the fall of King Bitcoin (BTC). In Panic, UST Holders Utilize UST Arbitrage and Burn Mechanism equivalent in LUNA print, which they sell immediately to cover up. This creates a bearish double pressure on the course of the LUNA which inevitably leads towards the abyss.

UST de-indexes, safeties do not work

We have all the ingredients for an explosive cocktail, ready to ignite at any time. The trigger came this weekend. A supposed liquidity-focused attack on Curve Finance used $ 350 million of UST to drain cash, resulting in the first depeg from UST up to $ 0.97.

However, the arbitration mechanism weakens and fails to properly restore UST price indexation. This is where the Luna Foundation Guard (LFG). Responsible for ensuring the security of the stablecoin, the foundation sold its reserves of bitcoins to buy back UST and try to raise the price.

As a reminder, since the beginning of 2022, the LFG has accumulated $ 2 billion worth of Bitcoin. to build a safety reserve. In particular, he worked with investment funds to buy Over The Counter (OTC) bitcoins in exchange for LUNA at a reduced price.

Unfortunately, the LFG’s strategy is struggling to restore the UST course. Addressing $ 20 billion capitalized stables, the 2 billion in the reserve was not enough. In addition, these bitcoins, bought on average $ 42,000, had already lost more than 15% of their value at the time of their forced sale.

While 2 billion dollars of BTC sold may look paltry compared to the 600 billion dollars of market capitalization of the first cryptocurrency on the market, the impact is enough to provoke panic.

Panic engages the market

These are a well-known fact the emotions that dictate the market situation cryptocurrencies. Given the suspected attacks on the UST, the deepening of the dollar price and the failure of the stablecoin security system, this is the beginning with a huge wave of panic.

The users sell their UST heavily, as evidenced by the total value locked in Anchor protocol, which fell 85% in one week:

Figure 2: Total Locked Value (TVL) at Anchor

As a result, the price of UST continues to fall. The LFG security reserve is empty, as are the various Bitcoin wallets belonging to the Terra foundation. Yes there are no more security measures to hold the stablecoin, trust is completely lostpanic continues to hit the ecosystem.

Order books are empty

On the other hand, the situation with centralized exchanges is deteriorating. Faced with a panic sale, Binance decides temporarily suspend withdrawals in UST from its platform, adding fuel to the fire.

However, the exchange has taken a storm and the order book is completely empty : no more purchase orders and no more possibility to sell its UST.

To understand this, you have to say that stablecoins do not work like other cryptocurrencies. If Bitcoin falls, purchase orders will always be placed on the old supports: $ 28,000, $ 20,000, and lower. For stablecoin, this is not the case. Its price is set between two mountains by volume about $ 1.

Where the UST price falls below the lower limit on purchase order volumes, nothing more could hold the pricesince no purchase order has been settled.

👉 To return to the facts – Terra: UST stablecoin hits $ 0.22, LUNA loses -89% in 24 hours

What about the impact on the ecosystem?

The future of LUNA and UST

At this stage, that it is practically impossible determine how big the Terra problems and its UST stablecoin are as a result of the collapse in the cryptocurrency market or how big the cause is.

On May 10, after hitting the first minimum of around $ 0.6, The UST managed to rise above $ 0.93. At the end of the day, Terra’s creator, Do Kwon, wanted to reassure the public: “No time to announce recovery plan for UST. Stay with me ”.

Close announce your recovery plan for US $. Hang tight.

– Dean Kwon 🌕 (@stablekwon) May 10, 2022

However, we later learned that the Terra Foundation would have been acquired agreement with various investment funds to raise an additional $ 1.5 billion in order to replace the UST peg. Alternatively, LUNA tokens were sold at half price to investors.

The euphoria was only short-lived, the UST course relapses violently until it reaches $ 0.22. At the moment, nothing indicates that he will be able to re – index himself to the dollar. Moreover, as long as the UST price is lower than the dollar price, The price of LUNA will continue to falland this, due to the burn and mint mechanism mentioned above.

DeFi was all influenced

Within 24 hours, the Terra blockchain lost 75% of its Total Locked Value (TVL). At the head of the bow, Anchor went from $ 18 billion to just $ 2.3 billion from TVL. The same is true for Mirror Protocol, whose MIR signal has been reduced by almost 60%, causing a lot of liquefaction among users.

Figure 3: Total Locked Value (TVL) on the Terra Blockchain

The fall reflects the Terra ecosystem and its UST stablecoin terrible threat to all of DEFi. The UST has been extended to many other ecosystems, in particular through the “4pool” on the Curve Protocol, including liquidity loss it directly affects some protocols such as convex (CVX) or Frax (FXS).

In addition, for the Curve Protocol, the liquidity pools consisting of USTs are being vacuumed. For USDT-3Pool and USDT + 3Crv v2 worm pools, number of transactions respectively which are 5 and 10 times larger than the liquidity that makes it up.

Figure 4: Different Pools of Curve Finances

In addition, the pools are no longer fully balanced. This shows of user capitalization and a total loss of confidence in UST’s ability to recover his pen.

The Terra community eagerly awaiting the news its director, Do Kwon. Will UST and LUNA succeed in rebounding? What will be the future impacts on the DeFi ecosystem and the cryptocurrency market? Only the future will tell us.

👉 Learn more – Luna Foundation Guard (LFG) to lend $ 1.5 billion in Bitcoin (BTC) to keep UST stable

Sources: Figure 1: TradingView, Figure 2: DefiLlama, Figure 3: DefiLlama, Figure 4: Curve.fi