The cryptocurrency market shuddered on Wednesday after the stablecoin UST plunged to an all-time low of 30 cents.
UST or TerraUSD was down around 9% to $0.427965 while its sister token, Luna, was down nearly 40% to $1.59 in its last confirmation. coin geckoIt is down 99% from its all-time high of $119.98 on April 5th.
TerraUSD briefly lost the dollar peg over the weekend and Luna also fell.
Bitcoin, the world’s largest digital currency, recently dropped 7.5% to $29,759.54, down 57.4% from its all-time high of $69,044.77 on November 10, 2021.
What is a stablecoin?
A stablecoin is a type of cryptocurrency that provides price stability and is backed by a reserve asset.
UST and luna are the main tokens of the Terra protocol, a decentralized open-source public blockchain protocol for so-called algorithmic stablecoins backed by computer code instead of collateral.
What happened to UST?
UST acts like a stablecoin like Tether that tracks the dollar price. However, unlike Tether and other stablecoins, there is no traditional asset such as cash or treasury to back it up.
UST is created (issued) by destroying its sister token, luna, via smart contracts, computer code that determines the terms of a transaction (loans, transactions, etc.) and does not rely on any third party. And vice versa. luna is mined by burning UST and other stablecoins supported by the Terra ecosystem.
Luna is the basic governance system of the Terra ecosystem.
UST’s dollar peg relies on a mechanism to create and burn coins with Luna. Basically, an investor can exchange 1 UST for 1 dollar of Luna. In doing so, they destroy or burn the UST. They basically take it out of circulation.
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The Terra ecosystem protocol also has an arbitrage mechanism that allows investors to benefit from price fluctuations. For example, strong demand for UST could push the price above $1. This means investors can convert $1 worth of Luna into UST and collect the difference.
If the price of UST is too high, investors are encouraged to burn Luna and create UST. Basically, they increase the supply of UST while reducing the number of Lunas in circulation. As a result, the luna becomes rarer and becomes more valuable. Since the two tokens evolve simultaneously, the value of UST also increases.
In general, this mechanism does the opposite when the UST price is low. Then, in theory, UST, which contributes to price stabilization, should be burned and Luna should be generated.
This balance is difficult to maintain in practice during periods of high volatility. This is what happened over the weekend of May 7th and 8th. Hundreds of millions of USTs were sold almost simultaneously on Terra’s trading platform Anchor, cryptocurrency exchange Binance and decentralized exchange Curve Finance.
Some sources in the industry speak of a joint attack on the UST as all orders were sell orders. The platform quickly lost a large portion of UST liquidity as many people were trying to spend the tokens at once.
What is happening now?
For reassurance, South Korean cryptocurrency entrepreneur Kwon Do, who co-founded Terraform Labs, plans to purchase $10 billion worth of Bitcoin through the Luna Foundation Guard (LFG). This fund acts as a backstop in case the value of the UST declines.
Therefore, Bitcoin will be the reserve currency of the Terra ecosystem.
The plan is to allow UST holders to exchange their tokens for Bitcoin. But how does this actually work? We don’t have an answer yet, as we didn’t expect Bitcoin to play the role of Luna when the crisis hit.
LFG currently holds $3.5 billion worth of Bitcoin (BTC). On Monday, the foundation reported spending $1.5 billion of those funds. To protect the value of UST, we are lending $750 million worth of Bitcoin to trading companies and will continue to accumulate Bitcoin using $750 million worth of UST.
However, some are concerned that the Bitcoin price will fall. In fact, there are concerns that LFG will have to liquidate its Bitcoin position if the UST loses its dollar peg again.
The foundation said “LFG is not trying to get out of Bitcoin’s position.” “The goal is to entrust this capital to professional market makers.”