YEREVAN (CoinChapter.com) – Terra’s governance token LUNA suicide resonated across the broad crypto market, as the digital asset rapidly lost virtually all value along with sister stablecoin TerraUSD (UST). Do Kwon, the chief executive of Terraform Labs, the company behind the token, commented on his platform’s demise, saying he was “heartbroken.”
He added that Terra “should look to preserve the community and developers that make Terra’s blockspace valuable.”
Moreover, the CEO added that Terra LUNA suicide could be reversible, as the community proposes several revival plans. Do Kwon also asserted that he did not benefit from the crisis in any way.
I still believe that decentralized economies deserve decentralized money – but it is clear that UST in its current form will not be that money. Neither I nor any institutions that I am affiliated with profited in any way from this incident. I sold no luna nor ust during the crisis.
As LUNA crypto suicide resonated with the rest of the crypto market, it is important to review the reasons behind the crash and the possible outcomes.
Terra LUNA spirals out of control – what happened?
Terra shook the crypto community in the previous week. LUNA and UST spiraled out of balance, losing their value. As a result, LUNA’s price stood at $0.0003 on Sunday, while UST lost its dollar peg and charted at merely 18 cents. Thus, it’s crucial to list the chronological order of the events.
Panic across the market
In detail, there are several reasons for LUNA suicide. The first trigger was the general panic across the community. The broader market conditions, the war in Europe, growing prices for fuel, and dreadful inflation reports set the stage. As a result, many traders were prone to making panic-driven decisions.
The psychology behind trading decisions is often overlooked. However, general instability can cause much more damage than traders generally admit. For example, an unstable state of mind while longing or shorting assets can lead to rash, emotion-based buys, and sales.
Additionally, the Bitcoin price tanked, effectively triggering a panic sale across the altcoin market. At the same time, UST started experiencing problems with its dollar peg. Thus, many traders, who were unaware of why UST was losing its peg, lost balance quickly and sold the stablecoin, digging a deeper hole for LUNA.
UST lost its peg, dragging LUNA down
Firstly, LUNA and UST are closely interconnected. For example, to mint algorithmic stablecoins, Terra burns LUNA tokens. Thus, LUNA is also used to correct UST’s dollar peg when the latter is unstable, serving as a floating ‘price shock absorber’ for UST volatility.
The story of UST’s depeg started with Anchor Protocol, a significant lending/borrowing platform built on Terra. In detail, one of the earliest signs of things going wrong for the stablecoin came when UST deposits on Anchor started dropping on Saturday, May 7. It is worth looking deeper into the Anchor-related side of the story.
Anchor has been steadily reducing the rates it offers holders for depositing UST. The said rates stood at a whopping 20%. However, the protocol passed the so-called ‘Proposal 20’ back in March, heavily affecting the 20% returns.
Anchor’s 20% interest rates were doomed.
In short, the proposal tied interest rates to the UST reserve. A 5% increase in Anchor’s UST reserves would subsequently lead to a rise in interest rates. Conversely, if these reserves decreased by 5%, the interest rate would also decrease.
Moreover, the imbalance between lenders and borrowers could drop the interest rates by 1.5 percentage points each month. As it became increasingly clear that the 20% interest rate would not last, traders lost interest in depositing UST.
Meanwhile, as of late April, nearly 72% of all UST reserves were locked on Anchor, which on May 6 stood at roughly 14 billion UST. Fast forward two days and the reserves shrunk to 11.7 billion. As UST maintained its dollar peg at the time, an equivalent of over $2 billion was allocated over the weekend.
Terra LUNA suicide proceeded.
As mentioned, traders lost interest in holding UST. Thus, the incentive to get rid of it ran high. One of the ways to unload UST is Terra’s burn-and-mint mechanism. In short, Terra lets holders swap 1 UST for $1 of LUNA, burning the UST in the process. Thus, if UST falls below its $1 peg, anyone can buy the said UST and trade it in for a $1 worth of LUNA for profit.
Conversely, if UST gets above $1, traders can swap and burn the $1 worth of LUNA to mint UST. This means that when investors started unloading their UST in bulk, LUNA supply rocketed, dropping its value in the process. The charts below demonstrate the mechanism.
The LUNA supply skyrocketed simultaneously, sending the price tumbling down.
As a result, LUNA price dropped from nearly $120 in April 2022 to $0.0003 on May 15.
How Do Kwon stablecoin demise affect the market?
Stablecoins besides TerraUSD failed to live up to their billing as the collapse of the algorithmic token has investors pondering the implications of the tumult for the broader market.
Experts agree that UST’s depeg, coupled with LUNA suicide, will send ripples across the crypto market, putting algorithmic stablecoins under scrutiny from authorities and traders. For example, Paul Veradittakit, a partner at Pantera Capital, asserted that risk mitigation would be necessary from this point forward.
The effects of the UST collapse will bring a bit more caution while evaluating other algorithmic stablecoins for investment. [Apps built on Terra] will likely want to diversify platforms to mitigate risk and apps that are tapping into Anchor for yields will have to tap into other cryptocurrencies and liquidity protocols.
The implications of the LUNA suicide will resonate not only with the rest of the crypto market but will also have a lasting effect on the future of algorithmic stablecoins. CEO Do Kwon also agreed that the UST stablecoin model might have failed.
However, the community plans to set Terra revival plans into motion that might revive the cryptocurrency. As of May 15, LUNA and UST have been delisted from several leading platforms.
Lilit is a Yerevan-based Markets writer, skilled in 3 languages, and interested in writing about the tech world, trading, art, and science. She also has a background in psychology and marketing, which helps deliver the right message to the target audience.