The Latest:
- UST fell as low as $0.65 on Monday, hinting at a possible collapse of the market-leading algorithmic stablecoin.
- LUNA, UST's shock absorber, fell 50% to $30.
- The Luna Foundation Guard, responsible for maintaining the stablecoin's peg, used up all of its bitcoin reserves and bought another 850 million BTC to defend UST's peg.
- Terra's defenders deployed hundreds of millions of dollars worth of Bitcoin to protect UST's peg, leading to claims that this may have led to selling pressure that contributed to Bitcoin's 10 percent price drop on Monday.
The algorithmic stablecoin UST lost its peg to the $1 exchange rate for the second time in three days on Monday, falling as low as $0.65, according to CoinMarketCap's latest price estimates. As UST has "depegged," the price of LUNA, its sister token, has dropped 45% to $33 in the last 24 hours according to CoinMarketCap.
The price development prompted Terra's bitcoin reserve manager, Luna Foundation Guard (LFG), to scoop up and quickly deploy 28,205 bitcoin to defend the bond by buying UST and providing liquidity on exchanges. This action coincided with a slight recovery in the UST price, which rose from lows in the $0.65 range to $0.78 by press time.
As the bitcoin price fell 10% on Monday alone, both UST supporters and opponents wondered to what extent LFG's bailout attempts had exacerbated the bitcoin selloff that has taken BTC to its lowest price since July 2021.
While Terra supporters continued to signal confidence Monday, many longtime critics were quick to say, "I told you so." Some even drew parallels between Terra and IRON Finance, a stablecoin that fell to zero last year in what has been called the first major bank run in the crypto world.
"There are still enough reserves to support the peg," Jose Maria Macedo, a member of the LFG Council, told CoinDesk when UST's depeg first became apparent.
UST, a so-called algorithmic stablecoin, works with LUNA to maintain a $1 price using game theory and a series of blockchain-based mint and burn mechanisms. In an ideal world, these mechanisms are intended to ensure that traders can always exchange $1 worth of UST for $1 worth of LUNA, which has a variable price and is intended to serve as a kind of shock absorber for UST price fluctuations.
Centralized stablecoins like USDC and Tether form the foundation of decentralized finance (DeFi) with their fully collateralized responses to the digital dollar, but Terra's "decentralized" UST stablecoin has recently nipped at their heels with a market cap of over $18 billion.
Terra claims its algorithmic stablecoin will wrest power from centralized institutions and failed monetary policy. Skeptics claim the entire system is a Ponzi scheme backed by memes, fake fundamentals, and whales.
A UST collapse would throw the entire DeFi industry into turmoil and set alarm bells ringing among regulators as they realize that retail investors are being left high and dry.
The shape of things to come
Trouble was already brewing at Terra last weekend, when large UST sales by a Terra whale and precipitous withdrawals from the UST money market sent Anchor UST briefly as low as $0.985 on Saturday.
As of last Friday, 75% of UST in circulation was deposited in Anchor, which has historically lured investors with annual returns of 20%.
UST deposits at Anchor fell from $14 billion to about $7 billion in the wake of the 72-hour UST price drop.
UST's heavy reliance on Anchor has long caused tension between the stablecoin's supporters and critics who claim Anchor's returns are artificially inflated by Terraform Labs (the creators of Terra) and its backers such as Jump Crypto and Three Arrows Capital.
Over time, critics say, Anchor would have been forced to lower returns to the point where users would have had no incentive to keep UST on the platform. In a world where there are few other uses for UST, such a scenario would have put the fledgling currency in trouble.
To counter these and other criticisms, Terraform Labs CEO Do Kwon bought massive amounts of Bitcoins to create a kind of partial reserve for UST. The Bitcoin reserves, which have no concrete connection to the smart contracts powering Terra's UST stablecoin, went into the hands of the newly formed LFG.
On Monday, LFG announced it would lend the reserves to professional market makers for the first time to defend UST's peg.
The reserves, which were increased by another $850 million on Monday, were used to defend UST tying to exchanges such as Binance and Curve.
While Macedo, the LFG council member, expressed optimism to CoinDesk that the BTC reserves would be enough to defend the UST peg, not everyone agrees.
According to Kevin Galois, a hedge fund manager and Terra critic, "[Terra] has barely bought itself a day with their $750 million defense strategy."
"At this point, they're either bleeding LUNA of the maximum convertible amount per day, or they're recapitalizing UST debt for pennies on the dollar. So either haircut for UST holders or massive losses for LUNA holders," Galois wrote to CoinDesk.
Perhaps the most consequential result of Monday's price action is that Luna's market cap has fallen below UST's. This potentially jeopardizes UST's entire stabilization mechanism, which is based on the idea that 1 UST can always be exchanged for $1 of LUNA.
If UST is more valuable than LUNA, Terra risks becoming insolvent if a bank run ever occurs.
What people are saying
Throughout Monday, Terra's Korean-based founder, Do Kwon, remained uncharacteristically silent: "deploying more capital - steady lads" was his only tweet.
Amid Kwon's silence, Terra's retail supporters, known as "LUNAtics," appeared to be grappling with the possibility of Terra's collapse. One member of the 31,000+ member Discord community lamented the price drop as a "massive hurdle" preventing observers from "accepting the whole concept of Terra + UST: Decentralization."
By 9:00 p.m. New York time, Terra's Discord moderators had set "slow mode" to one hour to keep LUNAtics' fears at bay.