Terra was once hailed as a promising blockchain ecosystem, with a price-stable global payments system and a utility blockchain that allowed third-parties to launch DApps; such as the revered Anchor Protocol, which offered UST staking returns of up to 20% per annum.
In the last week, the Terra native governance token, LUNA, and algorithmic stablecoin, TerraUSD (UST), have crashed, with LUNA currently trading at $0.00018, down from its all-time high of $119.18, and UST trading at $0.12, a fraction of the purported 1:1 peg to the US Dollar.
How did this happen?
Unlike other stablecoins, which are ordinarily pegged 1:1 with a fiat currency and backed by fiat currency reserves or commercial paper, LUNA’s UST peg was based upon an algorithm linked to the minting and burning of LUNA.
The algorithm ensured that when UST is minted, the equivalent in LUNA is burned. Accordingly, when UST is burned, the equivalent in LUNA is minted.
In theory, the algorithmic stablecoin and calculations served to promote the utility of LUNA and UST within the Luna ecosystem, and ensured that at all times users could freely convert LUNA to and from UST in a risk-free manner.
Practically, and taking into account the LUNA Foundation Guard’s considered Bitcoin acquisition strategy, with the downturn in global markets due to a number of factors including central bank interest rate hikes, many UST holders sought to exchange their UST to LUNA to liquidate their positions back to fiat currency. The result of this led to a de-peg of UST from it’s 1:1 USD peg, and the minting LUNA, resulting in an increase of the circulating supply.
The fears associated with the de-pegging of UST and the decrease in price of LUNA, as a result of its increasing supply, created immense fear within the market and a vicious spiral of devaluation as holders looked to liquidate their positions.
In an attempt to limit any further devaluation, the LUNA Foundation Guard commenced liquidation of their 80,000 BTC holdings to assist in providing liquidity to the token and stabilise the UST peg.
However, the liquidation had the opposite effect, instead creating further fear and the reduction of LUNA’s tangible asset holdings which were in fact a key consideration in the valuation and appeal of LUNA. It is reported that the LUNA Foundation Guard’s BTC holdings now sits at approximately 313, nominal compared to the prior holdings of 80,000.
With a circulating supply of LUNA sitting at approximately 6.5 trillion, as compared to its previous supply of 345 million, a UST stablecoin built on an algorithm that has failed, the loss of trust in LUNA and UST, and many LUNA supporters losing their life savings as a result of the inflation in circulating supply, it seems unlikely that the Terra ecosystem can salvage itself without the assistance of external capital.
Further with the volatility associated with LUNA and UST, many exchanges have moved to delist both LUNA and UST indefinitely, leaving many holders with the inability to trade or liquidate their holdings.
LUNA has announced a recovery plan, however, it is yet to be seen whether such recovery plan can restore LUNA to the promising project it was touted to be.
By Krish Gosai
Head of Crypto
If you would like to speak to one of our Cryptocurrency Experts, the team at Salerno Law are here to help.