What Happened: Luna/UST

Documenting the Fall of Luna

May 24, 2022

Last week’s “30 Life Lessons at 30” had a good response, so thank you to all those who replied/messaged me.

If you’d like to see the post in Twitter thread form, you can do so here, or listen to a debrief of the post I did with my friend & podcast co-host Nadim, here (apologies for the poor audio quality, it was an impromptu pod!). You can also re-read the whole post here.

Today’s post is one you’ve probably seen or heard about in every newsletter or news site as of late.

The market practically crumbled a couple of weeks ago, thanks to what was the 4th largest project by market capitalization, practically going bust.

We’re talking about Terra’s native tokens: UST & Luna.

UST is an algorithmic stablecoin (so ideally, a value of a single UST is always $1) and Luna is a token that helps UST to maintain this.

We’re going to talk about:

  • The UST / Luna relationship

  • What happened this week that broke everything

  • My thoughts on how we move forward

I know this narrative has been done endlessly already, but I’m writing to internalize the lessons for myself, so I hope you can bear with and I’d love to hear what you think.

Let’s get to it!

What is the “LUNA/UST” relationship?

The Terra blockchain powered the ‘stablecoin’ called UST - which is supposed to track the US dollar (so, 1 UST = 1 USD…theoretically).

It’s a stablecoin as it’s value is pegged to, and is therefore ‘stable’ versus - the US dollar.

It used another token, called LUNA, to ensure it’s stability. This was the value of UST (remember, it should always be $1) after 9th May:

LUNA, the token that worked alongside ‘UST’, had an even steeper fall:

So how does LUNA work and what’s the relationship to UST?

You can redeem $LUNA for $UST and vice-versa.

If $LUNA is at $100, you can redeem it for $100 of $UST. You can also redeem $100 of UST for 1 $LUNA.

This is meant to be a ‘stablizing mechanism’ that helps keep $UST at $1.

For example, if $UST is trading at $0.99, investors can buy it and redeem it for $1 of $LUNA, pocketing $0.01. The trading for $LUNA reduces the supply of UST, and drives the price of UST up to $1. Vice-versa, if the price of

What makes it an algorithmic stablecoin?

This means that UST is backed up, not by dollar-for-dollar reserves like USDC, but by the process of ‘burning and minting’ the $LUNA/$UST tokens (burn one, mint the other aka create more supply of) to keep the price steady.

This makes UST prone to an attack as they don’t have the actual dollars to back it up incase disaster strikes (which is what happened).

This also means…UST has no ‘collateral’ backing it (apart from approx $3bn worth of Bitcoin that the founder, Do Kwon, purchased to back UST/Luna incase a de-peg occurred) and relying on LU

Why would people use LUNA or UST other than for a fun arbitrage opportunity?

The problem with cryptocurrencies to date is that they’re not actually used as currencies.

They are used as investment vehicles (in other words, the expectation that ‘numba go up’). Obviously this hasn’t proven true (like with anything), however, in order for it to actually be used as a currency, use cases need to be found.

So where does $UST get utility and increase adoption?

This is where we welcome, Anchor Protocol.

Anchor Protocol was essentially a high-yield savings account, at a whopping 19.5% to stake $UST.

Anchor incentivised everyone to hold $UST and earn 20% per year to hold it.

Was this going to stay at 20% forever? No.

But, was it a cheap marketing tactic to acquire more users and increase user growth? Yes.

So, What Actually Happened?

On May 7th, the Curve pool (a decentralized exchange optimized for trades between like-assets such as stablecoins) became unbalanced. $85m left the Curve pool relatively quickly, sparking panic and other major sell-offs and withdrawals for other coins in the Curve pool (3CRV).

This started a chain of events, impacting the UST peg on Binance (the most liquid centralized exchange for the stablecoin).

Even LFG’s (the Luna Foundation Guard) announcement of deploying $1.5bn of its reserves to defend the UST peg wasn’t enough to bring back confidence in UST.

From then on, over the next week, the market reacted in a tumultuous manner, fending off rumours that large institutions were behind the de-peg and dealing with the rapid exit of large swathes of liquidity.

Anchor depositors continued to flee en masse, with the protocol holding just $2.18 billion in UST deposits, an 84.49% decrease since before the beginning of the crisis.

The only way in which UST holders can exit is by minting new LUNA and selling it on the open market.

In this time, LUNA’s supply ballooned by 8190% from 380m to 32 billion within 48 hours, causing LUNA to drop 99.1% from $31 to $0.01.

This means:

LUNA’s valuation has been destroyed - $41bn wiped off its balance sheet since April 5th.

Implications

Although events are still to play out, the collapse cannot be understated.

Many people lost a large amount of their net worth and life savings (yes, we’ve all heard the adage ‘don’t put more than you can afford to lose etc’ and I agree with this, but I still feel for them).

This catastrophe will likely bring a ton of regulatatory eyes, in particular towards stablecoins.

Also, it will strengthen the case for more collateralized/over-collateralized options for stablecoins to succeed, and even then, there remains a layer of uncertainty around how they operate.

What does this say about trust?

I read an interesting post about how we view ‘trust’.

For instance, stablecoins that become ‘depegged’ at $0.98 are more likely to shake confidence compared to a more riskier asset, such as Bitcoin. If I see a 15/20% price swing on a certain day in Bitcoin, I will be less alarmed compared to seeing a tiny depeg to occur.

We have an unshakeable belief, until our belief is shaken.

It’s important we’re aware of the invisible risk we can take on from adopting projects like these - if we don’t know where the yield is coming from or how the model is making $, it’s probably from our hard-earned investment.

Be careful out there.

Additional Reading:

Until next time

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Fahim