All about Terra Luna Crash
The recent Terra UST crash, one of the biggest crypto crashes, has shaken the trust of investors and changed their notions about crypto coins.
The crash of the stablecoin TerraUSD, or UST, on the Terra blockchain, and LUNA, the governance crypto token of the same framework, is disconcerting news for many in the crypto world these days. UST is pegged to the price of the US dollar. It means that its value only fluctuates as much as the dollar does. And the dollar cannot undergo a drastic shift in its value as it is regulated by the government which has reliable mechanisms to keep it stable within affordable limits, as a significant level of volatility can adversely affect the economy of the country itself. In other words, TerraUSD or UST must be as stable as the USD. However, what was thought impossible has happened now. A stablecoin has proved unstable for the first time with the plummeting of the TerraUSD price.
Can Stablecoins Become Unstable?
Can Stablecoins Become Unstable?
Yes. But before going into that, you need to know how stablecoins work and what is it that keeps (or is supposed to keep) them stable in the first place. A stablecoin, unlike other general cryptocurrencies whose values may fluctuate and drastically go up or down anytime, is a fixed cryptocurrency in that it claims stability in its value as it is pegged to some fiat coin. Thus, stablecoins are a way out for those investors who are hesitant to make crypto token investments fearing that their values could collapse to zero at any time. And the best stablecoin is the one that stays the most firmly pegged to its reference fiat currency and falters the least with market fluctuations.
Ideally, a unit of stablecoin pegged to the USD price must cost $1. It doesn’t matter if the dollar fluctuates and goes up or down a bit at any time; the stablecoin will bear whatever value the dollar claims at the instant. However, it doesn’t happen automatically. There is some mechanism or the other acting backstage that helps one stablecoin unit remain equal to one dollar.
Usually, there are two methods employed for the purpose, and hence, by a broad classification, there exist two types of stablecoins. One is the collateral-backed stablecoin type and the other, the algorithmic type. In the former, some form of collateral must be securely held somewhere, usually with some financial institution, whose value will equal the total value of stablecoins issued. The collateral can be a fiat currency, some commodity such as precious metals like gold or real estate, or even another cryptocurrency.
In case of a considerable fluctuation in the value of the stablecoin leading to its volatility, a part of the collateral can be used to reinstate it to its stable condition. One of the most famous examples of stablecoins Tether (USDT) uses the fiat currency US dollar as collateral. It means that if 1 million USDT cryptocurrency coins are in circulation, $1 million must be kept as its reserve. It is a 1:1 ratio and each USDT coin is worth $1.
However, in the latter model, i.e., the algorithmic stablecoin, there is no collateral. Instead, it makes use of a financial engineering algorithm to keep the coin stable. The stablecoin in question, i.e., UST or TerraUSD is an algorithmic stablecoin that functions on the Terra blockchain developed by the Terraform Labs. It has its unique method of maintaining stability. While UST is Terra’s primary stablecoin for trading, its native coin LUNA serves mainly as a governance token. The interrelation between the two constitutes the core of the stablecoin algorithm.
In any case the value of UST goes above the $1 mark, traders are allowed to burn LUNA crypto coins to generate more UST, which increases USTs availability and brings its price down. Conversely, when the UST price dips, it means its volatility has increased, and traders burn UST to convert it into LUNA value. Thus, the system relies on a simple supply-and-demand mechanism to keep the stablecoin pegged to the US dollar.
One may as well say that such algorithmic stablecoins as UST are completely at the mercy of the traders to maintain their stability and their governing framework doesn’t have any inherent arrangement for it. David Gerard, the author of Attack of the 50 Foot Blockchain is critical of the idea dismissing it as an attempt to build something stable from unstable things. Nevertheless, the setup worked fine in normal conditions. However, there are exceptions when the rule doesn’t work as expected. And that’s what happened with the UST and LUNA cryptocurrency crash.
So, How Did UST Become Unstable?
In simple words, the drastic increase in volatility of the UST or TerraUSD which was beyond the level that could be controlled even by the LUNA token burning is known to be the primary reason for the instability and the subsequent crash of the Terra coins. The bulk of the UST exists in the Anchor Protocol, the crypto banking system of Terra. It functions within the same Terra blockchain as the UST and LUNA coins. Users deposit their UST in Anchor and get ANC tokens or Anchor tokens as a receipt. The protocol offers them the benefit of an APY (Annual percentage yield) of 19.48%.
The fall of UST leading to the crypto crash started on May 7th with large amounts of UST being withdrawn from Anchor. It gradually snowballed with more withdrawals as people panicked over the next few days. The volatility became so high that it was beyond the control of the LUNA coins to keep UST pegged to the dollar as per the algorithm. And on May 13 the UST in Terra Anchor came down to a mere $1.6 billion worth from $14 billion at the beginning of May, as per Wall Street Journal crypto update.
The UST crypto price per unit plummeted to around 30 cents from its $1 value, pulling down LUNA by 99.99% to bring it to lower than a dollar right from $80. It is noteworthy that a few days before the incident, UST had become the third-largest stablecoin beating Binance USD, the first and second being Tether and USD Coin, as per CoinMarketCap ranking. The Terra incident also disturbed many other crypto prices and affected the crypto assets of many investors, including bitcoin, whose value dropped to less than $26,000 as per cryptocurrency prices live charts, which is its lowest in over a year and a half.
But what led to such a situation of massive volatility of Terra stablecoins is a matter of speculation and crypto market news is rife with different analytical takes on the subject. Though many theories about the crypto crisis are floating around, with the available information sans evidence, no one can say for sure if any of the stories is true.
Charles Hoskinson, the founder of Cardano blockchain and the co-founder of Ethereum, shared an opinion from someone else on Twitter suggesting a conspiracy for crypto market manipulation behind the crisis. He captioned it ‘word on the street’ since he himself had no evidence to prove it. The alleged conspiracy theory goes like this: BlackRock and Citadel borrowed 100,000 bitcoins from the Gemini exchange, and called Do Kwon, the CEO of Terraform Labs that founded Terra, and informed him that they would like to offer 25,000 bitcoins at a discount in exchange for UST. Do Kwon fell for it and released an equivalent amount of UST, thereby increasing the UST liquidity. Before the higher UST liquidity could be managed, BlackRock and Citadel dumped all the BTC and UST to give a hard time to LUNA and strip it of all its value.
It was something that could instantly trigger massive withdrawals of deposits from Anchor. This Anchor-LUNA incident devastated the entire Terra framework, which also reduced the bitcoin price in the market drastically. It enabled BlackRock and Citadel to buy back their BTC cheaper and easily repay the loan, pocketing the difference. The allegation also says that BlackRock and Citadel played the game because they believed that Anchor was a Ponzi scheme. After all, it offered investors around a lucrative 19.48% APY while it received interest of 11-12% from borrowers.
However, Blackrock, Citadel, and Gemini – all have denied the allegations. Hoskinson subsequently deleted the crypto story and posted a reply to a criticizing tweet reiterating that it was not his theory but the ‘word on the street’. However, he added that an attack had taken place for sure, though we could not verify who the perpetrator was.
Another theory by ‘Onchain Wizard’ suggests a Soros-style attack in which the attacker gained $800 million. George Soros is known as the ‘man who broke the Bank of England’ due to his short sales of pound sterling worth $10 billion, thereby making a profit of $1 billion. He also formulated the ‘General Theory of Reflexivity’ for financial markets, which he elaborated on in his book The Alchemy of Finance. Paolo Ardoino, the CTO (Chief Technology Officer) of Tether, the largest among the list of all stablecoins, also apparently endorses the attack theory.
In addition to the above, CoinDCX Blog points to the possible bitterness of bitcoin maximalists and Ethereum veterans against Terra. The Terra Foundation had started amassing a lot of bitcoins to support the UST crypto until it became the second-largest holder of bitcoins with 80,000 of it in possession.
This was not the first instance of stablecoins crashing. Do Kwon had failed earlier too, with another coin, Basis Cash (BAC). It was also designed as a stablecoin in 2020 by him and some others in Terraform Labs, though he represented it pseudonymously with the name Rick Sanchez. It failed to stay pegged to the USD value too and was abandoned in 2021, and currently, its value is below one cent as per the CoinMarketCap chart.
All the above theories about the Terra UST-LUNA crypto crash are conjecture at best. They all have elements in common. Regardless of whether they are true or false, there are lessons anyone can learn from them. As Charles Hoskinson said in his tweet reply, that’s how we learn things.
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