- The implosion of terra’s UST stablecoin and its token LUNA wiped over $50 billion in paper value.
- The unprecedented scale and speed of terra’s unwind dragged the entire crypto market down.
- Crypto experts weigh in on what could befall the ecosystem now that both tokens are near zero.
In a matter of days, more than $50 billion in paper value has been wiped out from the collapse of terra’s UST algorithmic stablecoin and its native governance token LUNA.
In what could be the fastest wealth-destruction event in crypto history, the dramatic implosion of the terra ecosystem started only a week ago with UST falling slightly below its dollar peg over the weekend.
As the so-called algorithmic stablecoin continued to lose its parity with the dollar, investors rushed to sell their UST holdings in what was similar to a traditional bank run. The token has tumbled 87% in the past week to trade at $0.13 as of 4:00 pm in New York, according to CoinGecko pricing.
Once UST deviated significantly from its peg, terra’s native governance token LUNA also started crashing down to earth.
This is because UST’s dollar peg is maintained via an arbitrage mechanism where traders can always burn 1 UST for $1 worth of LUNA. If UST falls below $1, a savvy trader could buy the UST and exchange it for $1 worth of LUNA, pocketing the difference as profits. Conversely, if UST rises above $1, a trader could exchange $1 worth of LUNA for 1 UST.
The problem with the burn-and-mint mechanism is that it only works if people are willing to participate. To generate demand for UST, terra created the anchor protocol, which offered a nearly 20% fixed interest rate for UST depositors on its platform. The interest payments have been largely subsidized by Luna Foundation Guard, the nonprofit behind the terra ecosystem.
As investors rushed to burn UST for LUNA, the supply of the stablecoin dwindled while the supply of LUNA ballooned. At one point, the
of UST overtook that of LUNA, which has plummeted to essentially zero.
As of Friday afternoon, there were more than 6.5 trillion LUNA tokens in circulation, diluting LUNA’s pricing to $0.00008231, per CoinGecko data.
The precipitous fall of UST and LUNA exacerbated fears in the crypto market, which has been reeling from rising interest rates and tightening financial conditions.
To defend UST’s peg, Luna Foundation Guard is believed to have liquidated the $3 billion of bitcoin it had purchased to serve as reserves for UST. While the market impact of the liquidation is unclear, the selling pressure weighed on major cryptocurrencies including bitcoin, which tumbled to as low as $26,900, per CoinGecko.
What’s next for the terra ecosystem
With talks of a bailout plan stalled, Terraform Labs CEO and cofounder Do Kwon has proposed to restart the terra blockchain by minting one billion tokens for distribution to various stakeholders, according to The Block, citing Kwon’s post on a terra forum.
For some investors, the collapse of UST and LUNA has put the terra ecosystem beyond revival, but others believe that the blockchain still has a shot of making a comeback.
“One way in which terra can recover, and maybe the only way, is to focus on growing the layer one blockchain and its ecosystem whilst using either USDT or USDC as the stablecoin of choice,” Marcus Sotiriou, an analyst at the UK-based digital asset broker GlobalBlock, said in a Thursday research note.
He added: “If the layer one ecosystem grows successfully then they could potentially be able to pay off the debt eventually. At the moment though, there seems to be little hope for Terra, as well as UST and LUNA holders.”
Indeed, institutional investors in terra have been mostly silent as the tokens plummeted to zero.
Su Zhu, the cofounder of Three Arrows Capital and an early terra backer, acknowledged in a Friday Twitter thread that the terra ecosystem should have “done more to move slowly and safely” after critics flagged the risks of the stablecoin being attacked and losing its peg.
“This is Terra’s DAO hack moment,” Zhu said. “I will not pretend to know what the future holds but I will do my part to help.”
The aftermath of terra’s implosion
After one of the most turbulent weeks in crypto history, investors are growing anxious about the impact that such a crash could have on the crypto industry.
It remains to be seen whether hedge funds that bet heavily on LUNA might become insolvent and the decentralized finance protocols that deposited their treasuries in anchor protocol could keep operating.
Already, the UST meltdown has caught the attention of Treasury Secretary Janet Yellen, who used the incident to illustrate the risks of stablecoins and called for new regulations in a Thursday testimony before the House Financial Services Committee.
“There are long-term ripple effects on other stablecoins, even ones backed in full by cash or cash equivalents like USDT and USDC, and further impact on algo stablecoins like DAI, even though it is overcollateralized with ETH,” Mitchell Dong, the chief executive at crypto hedge fund Pythagoras Investments, told Insider in an email interview.
Richard Li, the CEO of NFT marketplace
.com, views terra’s boom and bust as more of a “short-term speed bump” in the crypto industry. The crypto investor claimed that he had about $200,000 invested in the UST but is not looking to exit his position.
“I believe this is a temporary shock to the system, it doesn’t change my long-term strategy,” he told Insider in a Thursday interview.