Last week, the stablecoin of Terra (UST) started falling from $1, which sparked a freefall for Luna, UST’s sister token to fall below 1 cent from an all-time high of nearly $120 just a few weeks back. The price of UST is still less than $0.2, while LUNA is trading at $0.00017 and there don’t seem to be any sign of a comeback.
What is a Stablecoin?
A stablecoin is a cryptocurrency that is generally pegged with a fiat currency like USD or EUR and its value is supposed to be very close if not the same as the currency it is pegged with. For example, USDT is a stablecoin pegged with USD and so its value is always supposed to be $1 or very close to that.
Stablecoins are supposed to be backed by the equivalent value of the corresponding currency, so the number of USDT there are, an equivalent number of US dollars are supposed to be kept as reserves by the governing company, for USDT’s case it is the Tether foundation. So, if a stablecoin has an equivalent reserve of the corresponding currency, it can easily remain stable even during catastrophic events, but in the case of Terra’s stablecoin, UST (TerraUSD), it is not pegged with USD but is kept afloat by algorithms, for which Terra uses its sister token LUNA to keep the value of UST close to $1.
Why such a fall?
Until March 2022, Anchor Protocol, which is built on the Terra platform, gave a yield(interest rate) of 20% per year for holding their coin. TerraUSD being tightly linked with Anchor protocol became like a stable currency that paid a 20% rate of interest. This made TerraUSD a very popular investment among crypto holders since it would give sure-shot returns. However, Anchor later announced that it will change this rate from 20% to a variable rate, which proved to be lesser rewarding leading to a mass selling of both TerraUSD and Luna.
Club this selloff with bad market conditions in the world, which made last week the lowest price of Bitcoin since Dec 2020, with an even worse scenario for altcoins, leading to the mass removal of investments from Crypto. The algorithm that ensured UST was kept at a dollar started to fail, and UST saw a sharp fall in price.
To compensate for this fall in UST, the Terra foundation had to sell a lot of their LUNA and BTC holdings so that they can cover up for the lack of funds to keep UST from falling further. This led to Luna falling from more than $100 to below a dollar in less than a week. But even this did not improve the price of UST.
It was a pure failure of the algorithm designed to guarantee the stable rates of Terra USD.
What has been done till now by Terra?
The LFG, Luna Foundation Guard, is an organization that is responsible for the wellbeing and support of the whole Terra ecosystem. On Monday, the LFG put out details of the use of their crypto reserves for saving the value of the UST on a Twitter thread. On May 9, they had 80,394 BTC which were valued at $3 billion at the time, and many other cryptocurrencies like USDT, USDC, BNB, AVAX, and LUNA.
In Monday’s tweet, the LFG revealed what it has done to peg the value of UST. It had to sell almost all of its BTC reserves, and now is only left with 313 BTCs, down from its original 80K BTCs. It used this money to buy UST and defend the stablecoin’s peg. The money was sent to a professional market maker, who would then deploy all the funds on behalf of the LFG.
First, they transferred 52,189 Bitcoin on May 9, worth around $1.6 billion, to crypto exchange Gemini. But later the next day, the price of UST was still $0.07, and as a final effort to save the peg, more 33,206 BTC was transferred.
Despite all these measures, the UST collapse could not be stopped, and the price is currently at around $0.08. The Luna Foundation Guard finally stated that they would use the remaining funds to compensate remaining users of the $UST, smallest holders first.
VitalikButerin, the Ethereum co-founder put forth a tweet saying, “Coordinated sympathy and relief for the average UST smallholder who got told something dumb about ‘20% interest rates on the US dollar’ by an influencer, personal responsibility and SFYL [or sorry for your loss] for the wealthy,”
Only $80 million worth of crypto is left in the LFG reserves, a minuscule figure compared to the target reserve of $10 Billion at the start of this month.