To the Moon! And then (crashing) back again: The demise of Luna and the UST Depeg
By Ada Capital Team
The UST was the 4th largest USD “stablecoin” (remember, always supposed to be pegged at around $1.00), with a market cap greater than $18 billion before recent events. The UST lost its peg and went to a minimum of $0.10 in SIX DAYS.
First of all, we need to understand the basics around UST/LUNA mechanics.
Simplifying: Without reserves to back its potential redemptions, UST has kept its peg working around LUNA - even if UST was < $1 people could still redeem 1 UST for $1 worth of LUNA (the opposite is true, people can also burn a dollar worth of LUNA to get 1 UST).
This in theory will incentivize arbitrageurs to keep the UST peg going. The question is: why would people want to hold UST while other fully backed (in theory) stablecoins like USDC, DAI, USDT, BUSD exist?
The first part to this equation is something called the Anchor Protocol.
This protocol basically permits everyone to stake their UST for almost 20% per year – most people thought that UST was simply a risk-free fixed-income like instrument that returned ~20%, and the Anchor Protocol reached almost $15 billion being staked at its peak.
The second part of this equation is LUNA.
The only way to get UST and also the 20% sweet returns is burning LUNA - this creates an incentive (besides the ecosystem concept itself) to hold LUNA tokens, as every time UST grows, LUNA supply shrinks and supposedly, LUNA tokens should increase in value.
So what’s the problem with this mechanism? The so called Algo-Stablecoin Death Spiral
Imagine a bear market, where the LUNA token’s value falls → With that, UST Holders could fear a peg break and sell their UST for LUNA → This will then increase the supply of LUNA, which further decreases its price and continues this vicious cycle (hence the death spiral).
In order to protect itself from such an event, the LFG (Luna Foundation Guard) raised over $1 billion in capital (with big names such as Jump Capital and Three Arrows Capital) to buy BTC and started transforming its protocol reserves into BTC as well.
With BTC in hands, in the case of the abovementioned scenario, they could burn the UST against the BTC and that would potentially break the death spiral and stabilize LUNA and UST values.
Everything now seems now to work perfectly in theory, maintaining the UST peg around the dollar. Now let’s dig into what happened since from May 7th onwards.
It all started with a UST sell-off on USD<>USDC Pool at Curve (a DeFi Protocol) that quickly reached the media and social networks, and people started panicking (if you are going to panic, do it first!)
This initial scare caused a $2 billion withdraw from Anchor and the UST moved to 0.985 (remember, 1 = 1 is key!)
Then, a bigger sell-off started on 3/4-pools at Curve and the panic really started - UST went to 0.97 and Anchor withdrawls exploded to a million dollars per minute.
All of a sudden, another massive UST sell-off started at Binance, and that initiated the death spiral – in a bid to stabilize prices, LFG then started selling BTC for UST to try to restore the peg
This massive sell-off of BTC then put pressure on BTC prices which began to plumit, and the whole Crypto markets were infected, inflating panic across the board.
Anchor deposits went from $14 billion to $8 billion in a matter of 3 days, with many selling UST on exchanges with fear of a massive de-peg – this of course turns out to be a self-fulfilling prophecy, and on monday UST went below $0.80.
In addition to that, the LUNA price started to collapse because of the fear of LUNA increasing supply – the public reached the (correct) assumption that LFG’s Bitcoin reserves would not be sufficient and the Death Spiral would gain momentum.
Seeing blood on the streets, traders started building up massive short positions against LUNA and UST and the markets reached full panic mode, and it was near impossible to stop the death spiral.
All this movement and a weak rescue plan ($1.5 billion raise announced was far from the necessary capital LFG needed to get everything back on track again) made the market dump all LUNA and UST.
By Thursday 13th, the aftermath of UST-Day, the UST finally reached an astounding UST 0.10 and LUNA went from $80 to a scarcely unbelievable $0.000008.
In six days almost $50 billion eroded from the markets, and fortunes were lost and squandered - an unprecedented value destruction on Crypto history.
More about how the de-peg began: twitter.com/OnChainWizard/status/1524123935570382851
Ada Capital
ir@adacapital.com.br