How Terra’s Implosion Affected the Entire Cryptosphere

How Terra’s Implosion Affected the Entire Cryptosphere

What happened after the Terra LUNA implosion?

Terra’s dramatic fall began on May 7th, 2022, when UST, Terra’s stablecoin lost its peg to the USD dollar. Stablecoins are designed to keep a steady value, and investors will always get alarmed if the value of a stablecoin goes off track. In the case of Terra’s UST stablecoin, the value dropped to $0.35 by May 9th, which cause the entire ecosystem to collapse in a matter of hours. It was only downhill from there, with some occasional small price spikes, whenever the official Terra Twitter account or its founder tweeted something new. 

What caused the Terra LUNA implosion and the subsequent death spiral?

It’s important to note that UST is an algorithmic stablecoin. This means that the asset isn’t collateralized by the same value of fiat in some bank account, or by any other crypto, such as BTC or ETH. An algorithmic stablecoin is a digital asset that is designed to preserve a certain value at all times, by incentivizing users to sell it or buy it, when its price fluctuates. 

At the same time, the stablecoin is a rebase token and the algorithm needs time to adjust its total supply, based on the action of the users. In the case of the Terra blockchain, the stablecoin (UST) was adjusting its price by using another asset, LUNA, the native coin of the Terra blockchain. When the price of UST began to wobble, there was huge pressure on the blockchain, as users started to take advantage of the design of the blockchain – the very system that was supposed to keep it afloat. 

Simply put, Terra would always allow users to trade 1 UST for $1 of Terra and vice-versa. The massive selling of UST for Terra caused unprecedented inflation on the Terra blockchain. The total Terra supply raised from 350 million Terra to over 6.5 billion in a matter of hours. During this death spiral of Terra LUNA, investors saw their life-saving shrinking to pennies in a blink of an eye. There were reported cases of suicide. This is a lesson to be remembered and a sign that the world is not yet ready for these imperfect algorithmic stablecoins. 

According to the on-chain analytics firm Nansen report, the reason the UST stablecoin de-pegged was a number of entities that reduced their UST allocations:

“We refute the popular narrative of one ‘attacker’ or ‘hacker’ working to destabilize UST. The de-peg of UST could instead have resulted from the investment decisions of several well-funded entities, e.g., to abide by risk management constraints or alternative to reduce UST allocations deposited into [lending protocol] Anchor in the context of turbulent macroeconomic and market conditions.”

The Terra implosion in numbers

At the beginning of 2022, Terra’s LUNA token had a market cap of $31 billion. Its stablecoin, UST, had a market cap of $10 billion. On April 5th, 2022, the old Terra LUNA, now called Terra Classic (LUNC), reached its all-time high at $119.18

Now, both have a virtual value of $0.

Shortly after the fall of the entire ecosystem, the damages of the Terra implosion were estimated at around $40 billion. According to LFG (Luna Foundation Guard), the network had vast reserves of over-2 billion dollars worth of bitcoin, but not even selling that was able to save all those UST and Terra investors. 

UST has remained de-pegged from the US dollar since 9th May 2022 and it was trading at $0.015 at the end of May 2022. 

According to DeFi Llama, the TVL (Total Value Locked) on the Terra network dropped from $29 billion at the beginning of May, to $15 billion at the beginning of June. 

How Terra’s Implosion Affected the Entire Cryptosphere

The Terra blockchain revival plan

The largest token collapse in crypto history could not simply let investors without hope. After Terra’s UST collapse, LUNA’s value was going lower by the hour. At some point, on May 12th, Terra validators halted block production to implement a new blockchain update that would prevent new actors staking on the Terra blockchain. 

Everyone was waiting for an update from Do Kwon, the blockchain’s founder, as the market was hitting lower values each hour. As of June 2022, his Twitter account has turned private. 

Terra LUNA imposion How Terra’s Implosion Affected the Entire Cryptosphere

On May 16th, Do Kwon, Terra’s founder proposed several versions of a revival plan, and the original plans included handing over the ownership of Terra to its community.  

The revival plan that passed the governance vote with a 65% approval rate introduces the Terra 2.0 blockchain, which is a hard fork from the original blockchain. The new Terra blockchain will hold onto its name, while the old blockchain will be renamed Terra Classic and its coins will be called LUNA Classic (LUNC) and UST Classic (USTC). 

The plan was to take a snapshot of the Terra blockchain and airdrop to Terra’s LUNA holders the new coin, which will also use the name LUNA. The snapshot took place on May 26th, 2022. 

The plan specifies that smaller holders would get their tokens much faster, than large holders who would have the power to destabilize the market if they would get the new coin and sell it from the start. 

To prevent immediate selling of the new LUNA coin and entering a new death spiral, investors who held over 10,000 LUNA before the collapse of the ecosystem, will receive the new coins over a vesting period. Initially, 30% of their tokens will be unlocked, and the remaining coins will be unlocked over the next two years. 

Moreover, crypto wallets that hold more than 1 million LUNA or UST prior to UST’s de-pegging from the U.S. dollar would have to wait more than a year before receiving any of the new tokens, with a four-year vesting period. 

Terra 2.0: the launch of a new blockchain 

On May 28th, 2022, Terra 2.0 was launched. The new blockchain is a hard fork from the now-called Terra Classic blockchain. All those who held Terra at the moment of the snapshot received the new LUNA token via airdrop.  

While some investors already received a part of their new tokens, other larger wallets will have to wait. 

As the new LUNA coin launched, its price saw huge volatility on exchanges. LUNA’s price reached $19.54 on the day of its launch but has been falling ever since. 

The crypto market is now in a bearish trend. Some argue that the recent Terra LUNA implosion (Terra Classic) and its algorithmic stablecoin have made investors lose confidence in cryptocurrencies and in stablecoins. 

UST Stablecoin Loses Dollar Peg But Terra Strives to Bring It Back Up

UST Stablecoin Loses Dollar Peg But Terra Strives to Bring It Back Up

According to the latest price estimates from CoinMarketCap, Terra’s stablecoin, UST has lost its USD peg as it fell to $0.36 on Wednesday, May 11th.

According to CoinMarketCap, the price of UST’s sister token, LUNA, has fallen over 96% to $1.17, following UST’s dramatic price drop. The online community is referring to this event as the #LunaCrash.

What is UST?

UST is a so-called algorithmic stablecoin. It works with LUNA in order to maintain a price at $1 by using a series of on-chain minting and burn mechanics. These mechanics are supposed to allow traders to swap $1 worth UST for $1 worth of LUNA. Luna has a floating price, and serves as a shock absorber to UST’s price.

Luna’s market cap falls below that of UST due to its price drop, reaching $763 million compared to $5.43 billion market cap of TerraUSD (UST). This could put at risk the entire stabilizing mechanism of UST. It means that Terra bank runs could result in some users not being able to redeem $1 of UST for $1 LUNA.

This is not the first time that the UST has been “de-pegged” from the $1 value that a stablecoin should have at all times. 

When a stablecoin isn’t stable anymore

The UST de-pegged that started at the beginning of May 2022 has urged the Luna Foundation to find a solution to this crisis and help the UST bounce back to its normal value. Luna Foundation Guard (LFG) announced on Sunday night that $1.5 Billion of its huge Bitcoin (BTC) reserves would be “loaned out” to professional market makers in order to proactively protect UST’s dollar peg.

However, the market cap of UST did not recover. 

Terra seemed to have emptied all funds (approximately $1.3 billion) from its verified bitcoin address.

Do Kwon, Terraform Labs’ CEO, posted a few minutes later on Twitter: “Deploying more capital — steady lads!”

According to reports, professional market makers use the BTC reserves to protect UST’s dollar peg in protocols such as Curve. Curve allows users to swap between UST (and other currencies) like the USDC and Tether stablecoins.

There is currently no link between Terra’s LFG reserves and Terra’s on-chain mint and burn mechanism. Although there are plans to bake Terra’s bitcoin reserve into its underlying smart contract, users currently have no option to redeem UST and LUNA for bitcoin.

This is a question that will remain unanswered, as the reserves appear to have been almost completely drained.

Terraform Labs CEO works to help UST regain its peg to the US dollar

Do Kwon, founder of Terraform Labs, said that the company supports a community proposal to help TerraUSD (UST), a stablecoin pegged with the U.S. Dollar, regain its peg.

Algorithmic stablecoins such as UST are backed with a range of assets like Terra’s LUNA and bitcoin (BTC). One UST can be redeemed for $1 worth of LUNA, so it is easy to keep its value.

However, UST lost the peg and dropped to $0.66 Monday, but it didn’t stop there. Although it recovered it’s value on Tuesday, when it reached $0.90, before falling to $0.35 during Asian hours on Wednesday. LUNA also dropped sharply.

Kwon, who has been unusually silent on Twitter over the last few days, said there was a plan for UST to be brought back to its original position.

Kwon explained how UST works in a tweet: “The price stabilization mechanism is absorbing UST supply (over 10% of total supply), but the cost of absorbing so much stablecoins at the same time has stretched out the on-chain swap spread to 40%, and Luna price has diminished dramatically absorbing the arbs.”

You can find the entire Twitter thread that Kwon wrote here.

Arbs is a term that refers to crypto arbitrage.

To try to bring UST’s peg down to $1, additional LUNA will be minted and would be sold on the market. This is in addition to a separate proposal that aims to offer a lower yield to users of Anchor.

The proposal states: “By allowing more efficient UST burn and LUNA mining, [which] will in short term put pressure on LUNA prices, but will also be an effective method to bring UST back to its $1 pegged-value, which will eventually stabilize LUNA prices.”

The story is still developing. Check the price of UST on Coinmarketcap