Terra Luna wiped out nearly $18 billion. To understand this sharp fall, we must first understand the idea of the stablecoin. Some of you who invest in cryptocurrency might be well aware of it. For starters, stablecoins are those whose value is pegged to a fiat currency, another cryptocurrency, a commodity, or a financial instrument.
By value, I mean the price of a coin; for example, XYZ stablecoin, whose price is pegged to the US dollar at a 1:1 ratio, meaning that if you liquidate one unit of XYZ coin, you will receive one dollar in return. There are other types of stablecoins too, such as those backed by gold, another cryptocurrency, and non-collateralized stablecoins, which are governed by algorithms.
The protagonist of our story, Luna, is the sister of UST, the 4th kind of stablecoin. Terra is a blockchain-powered by Terraform Labs, which produces Luna as its native currency. Luna is pegged to UST, which is an algorithmic or decentralized stablecoin.
How do the UST and Luna pegs work?
To create UST, you need to burn Luna. Before the great fall, Luna was trading at $85, which means you would get 85 UST for 1 Luna. But, in the process, Luna needs to be destroyed (burned). If more people buy into UST, more Luna would be burned, ensuring the remaining Luna supply is more valuable.
UST would always be exchanged for $1 worth of Luna. Now, if the price of UST falls, traders will be interested to buy UST and exchange it for Luna; in this process, UST will be burned, thus controlling the supply and pushing back the price.
Where did things go wrong?
One of the earliest signs that things were going wrong for the stablecoin came when UST deposits on Anchor started dropping in the first week of May 2022.
Anchor offers market-leading yields of up to 20% a year to users who deposit their UST on the platform. Before UST started its decline late on Saturday, Anchor was home to 75% of UST’s entire circulating supply. That’s $14 billion of UST out of a total circulating supply of $18 billion.
With so much UST locked up in Anchor, it became clear that most investors were buying the stable coin with the sole intent of reaping those sweet, sweet Anchor yields.
Things got messed up when $285 million worth of UST was liquidated on Curve and Binance, which means a lot of UST was dumped, which pulled down the price of UST, pushing up the supply of Luna. When huge LUNA tokens flooded into the space, the demand eased out. Therefore, the price was negatively impacted heavily. The number of Luna tokens in circulation went up from 343 million to more than 6.5 trillion in just a week.
Will Luna be able to recover?
The current LUNA price is $0. 0.000060. It may be impossible unless a large part of the hyper-inflated circulating supply of LUNA (now 6.5 trillion LUNA coins) is burnt. Furthermore, a new chain called Luna V2 has been launched, and the earlier coin has been named Terra Classic.
Crypto investors should apply extreme caution while investing.
Writer: Suraj Kar
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