Stablecoin UST loses dollar peg, while LUNA price is falling

    11 May 2022

    Stablecoin TerraUSD (UST) has lost its dollar peg, falling to as low as $0.65 on Monday. Meantime, the price of LUNA, its sister token, has dropped over 44% to $35 in the past 24 hours. The accident comes after the Luna Foundation Guard (LFG) announced that its massive Bitcoin reserves will be used to defend UST’s peg to the dollar.

    Over the weekend, the TerraUSD stablecoin (UST) slipped to around 99 cents. By Monday evening, it had plunged to 60 cents, breaking its previous low of 92 cents in May 2021. It set back losses on Tuesday and is fluctuating between $0.9 and $1, but it’s still a trouble.

    The UST un-pegging to $1 happened alongside a sharp selloff in crypto markets, while Bitcoin plunged to below $30,000, Bloomberg reported.

    UST is a so-called algorithmic stablecoin, which works with LUNA token to maintain a price of $1 using a set of on-chain mint and burn mechanics.

    Issuers of stablecoins like Tether’s USDT or Circle’s USDC maintain that their tokens are backed by “real” assets like cash or highly rated bonds on a 1-to-1 basis. These coins hold their peg because, in theory, they can be readily exchanged for cash or highly liquid cash equivalents. By contrast, algorithmic stablecoins attempt to hold their value through a combination of instructions encoded in software programs and active treasury management. UST – which functions in tandem with a related token, Luna — is the most popular and controversial of these kinds of tokens.

    If Terra’s price falls below $1, traders are incentivized to swap units of UST for Luna, which removes Terra from circulation. Software programs are triggered to do the same. If the price rallies above $1, the mechanism applies in reverse – remove Luna tokens from circulation to create equivalent, new units of UST.

    Traders seeking to profit from arbitrage opportunities regularly swap UST for Luna and vice versa, thus ensuring the price stays very close to $1. Another contributor to UST’s price stability was crypto’s equivalent of above-market interest rates offered through Anchor Protocol, a “decentralized lender” built on Terra’s blockchain. Anchor offers rates of around 20% on deposits of UST, which offered a significant demand incentive for the token.

    But over the weekend, all of those mechanisms stopped working, and UST lost its dollar peg, while Luna also slid in value. That led to a series of crypto market interventions from Kwon and the council of the Luna Foundation Guard (LFG), a consortium of crypto players that includes Kanav Kariya of Jump Crypto. Near midnight on Monday, UST remained under pressure, while Luna was trading around $29, down 52% from a day earlier, according to CoinMarketCap.

    LFG is a nonprofit incorporated last December, according to a business profile from Singapore’s Accounting and Corporate Regulatory Authority, where Kwon is listed as a director.

    Previously, Do Kwon, the crypto enthusiast behind UST, has committed to buying as much as $10 billion worth of Bitcoin as part of his support of the coin.

    “It’s fairly clear that there is a crisis of confidence,” Kyle Samani of Multicoin Capital told Bloomberg. He added that it was not certain whether UST would survive.

    “The biggest losers from all of this will be retail investors that didn’t understand the risks they were taking,” Samani added.

    Crypto market participants, regulators, and critics are keenly watching UST’s flailing to measure up the concept of algorithmic stablecoins, which rely on programs (over full collateral) to stay at $1 a coin.

    “I think that simply illustrates that this is a rapidly growing product, and that there are risks to financial stability, and we need a framework that’s appropriate,” Treasury Secretary Janet Yellen said of UST at a Senate hearing Tuesday.

    While the crypto community still tries to decipher Terra’s ongoing pegging-de-pegging fiasco with UST, major crypto exchange Binance temporarily suspended all withdrawals for LUNA and UST tokens, citing a high volume of pending withdrawal transactions. While acknowledging the possible inconvenience to its investors.

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