Terra has been making headlines recently and for all the wrong reasons. Despite being one of the largest cryptocurrencies in the world, Terra’s native token LUNA has had a disastrous few days, dropping significantly and costing investors millions. On the surface of things, this could just look like another rug pull designed to fleece investors out of their savings but in reality, it was a targeted attack aimed specifically at Terra. Let’s delve into the details.
What is Terra?
Terra (LUNA) is a protocol that utilizes blockchain technology to create decentralized fiat-pegged stablecoins designed to blend the decentralized nature of cryptocurrency with the stability offered by fiat currency. The Terra platform was a favorite among investors as it allowed users to earn up to 20% interest on their UST holdings, eclipsing the rates offered by traditional banking institutions.
There are two main currencies within the Terra ecosystem, LUNA and UST. LUNA is the native token for the Terra ecosystem, it’s used as a governance token meaning anyone holding LUNA can vote on future Terra updates. Additionally, LUNA is used to stabilize UST, with more LUNA getting minted if the price of UST drops below $1.
UST is Terra’s algorithmic stablecoin, meaning rather than being backed 1:1 by the underlying currency (e.g. USD), it’s instead backed by a separate crypto-asset (e.g. LUNA). As UST is pegged to the dollar, it should (in theory) maintain a $1 price. However, sometimes an event or series of events can cause enough volatility that the stablecoin loses its peg, which is precisely what happened to UST over the past few days.
What is a Stablecoin?
A stablecoin is a cryptocurrency designed to mirror the price of a fiat currency. There’s a multitude of different stablecoins out there, each of which tends to be tied to a specific blockchain (although some operate across multiple). Tether (USDT) is the largest stablecoin with a market cap of over $81 billion.
Generally, stablecoins can be grouped into two categories, ‘backed stablecoins’ and ‘algorithmic stablecoins’. Backed stablecoins as the name implies, are backed by fiat-based assets including cash, treasury bonds, and liquid debt assets. Because the underlying currency (e.g. the dollar) is fairly stable, this type of stablecoin typically stays fairly close to $1 even during times of uncertainty.
Algorithmic stablecoins on the other hand, are typically backed by more volatile crypto assets (e.g. LUNA). While 99% of the time both types of stablecoin act very similar to one another, if something happens that has a large impact on the price of the cryptocurrency underlying an algorithmic stablecoin it can have a snowball effect on the price of both the stablecoin and the underlying asset, this is exactly what caused the drop in LUNA and UST.
What Happened to UST?
By now you’re likely wondering what could have affected LUNA so negatively that UST depegged and LUNA dropped by 99%. Seemingly, a group or individual borrowed 100,000 Bitcoins before selling 25,000 to Terra in exchange for UST. Following this, the remaining 75,000 BTC were sold with the funds being used to short LUNA. Then, UST was dumped on Curve as its liquidly switched pools, leading to UST briefly de-pegging from the dollar. Lastly, the attacker dumped the rest of the UST on Binance, causing the price to drop further.
UST losing its peg was enough to cause mass panic with investors rushing to pay back loans and sell their UST, leading UST to drop even further. At the same time, UST’s balancing algorithm would've kicked in causing more LUNA to be minted in an attempt to keep UST at $1. Unfortunately, this led to the supply of LUNA increasing exponentially, in turn, causing the price to drop massively.
Both of these factors combined to cause a further de-pegging, eviscerating any hope LUNA/UST holders still had. People then rushed to get out of the Terra ecosystem, causing network congestion, leaving investors unable to pay back loans to withdraw their assets. Naturally, this caused more fear and panic, leading to the snowball effect we discussed earlier.
At the time of writing (12/05/22), the price of LUNA has dropped to around $0.09 from week ago highs of over $85, a 99.9% decrease. UST didn’t fare well either, it’s currently trading for $0.60, up 100% from lows of $0.30.
What’s Next for Terra?
If Terra wants to continue operating it’s going to have an extremely hard time building investor trust back up, who would want to hold a ‘stablecoin’ that has the potential to drop by 70% in a matter of hours. The Luna Foundation Guard (LFG) has been selling Bitcoin enmasse in an attempt to add more liquidity to UST and stabilize prices although this has had little effect so far. Despite the market cap of LUNA dropping from almost $30 billion to just $250 million, the team are still attempting to salvage things by pledging to burn over $1.3 billion in UST. As the supply of LUNA increases almost tenfold, it’s going to be near-impossible for the coin to return to its previous levels unless a ton of coins are burnt. Only time will tell how well LUNA and UST recover but for the time being, we advise sitting tight, steering clear from the Terra ecosystem, and perhaps using the dip to increase some of your other positions.
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