Crypto crash: What happened to Luna and UST?

SPECULATION is rife as to why Terra’s algorithmic stablecoin experiment crumbled. An understanding of how it was supposed to work may provide some clues as to why it didn’t. 

Unlike other stablecoins said to be pegged to tangible assets, TerraUSD (UST) was designed to work with its sister token, Luna, to maintain a one-to-one peg with the dollar. 

Terraform Labs, the company behind TerraUSD, was set up in Singapore in April 2018.

In theory, US$1 worth of UST can be used to mint US$1 of Luna. If UST falls below US$1, traders can profit by buying UST for the lower price and then trading it for US$1 worth of Luna. UST’s supply would fall, and its price be pushed up. 

If UST is trading above US$1, traders will be incentivised to exchange their Luna for UST, causing its price to fall. Such mechanics should eventually bring the price back into sync.

UST started to deviate from its US$1 peg last weekend, amid macro uncertainty and concerns over inflation. Meanwhile, substantial amounts of the stablecoin were being drained out of the Anchor lending protocol, said to be home to three-quarters of UST’s circulating supply then. Anchor runs on the Luna blockchain and promises up to 20 per cent in yields to UST depositors. 

Forbes reported the amount drained to be about US$5 billion, representing about 27 per cent of the stablecoin’s market capitalisation, while CoinDesk reported that UST deposits dropped from US$14 billion to S$3 billion through the start of this week.

Some have suggested that unknown actors were flooding the market with UST to attack the protocol. 

This drainage represented a loss of confidence in the Terra ecosystem, resulting in a massive sell-off and steep drops in the prices of UST and Luna. UST was trading at about US$0.40 at the time of writing, but had at one point fallen to US$0.26. Meanwhile, prices of Luna plunged by over 99 per cent – it was trading near-zero at time of writing.

Some critics have said the writing was already on the wall, noting that a 20 per cent yield for UST was abnormally high and unsustainable. 

Singapore-based Luna Foundation Guard, whose core mandate is to maintain the stability of the UST peg, was said to have deployed over US$2 billion in bitcoin reserves to keep the UST afloat, but that has not brought the equilibrium back.