It's fair to say we had a nose for trouble when we brought you a full feature on stablecoins in the Premium edition last week. UST, the stablecoin of the Terra ecosystem ($19 billion in capitalisation before its fall, $14 billion currently), has just lost parity with the dollar and dragged the entire crypto market down with it.
On Monday night, it fell to $0.60, before recovering on Tuesday to around $0.90 and falling back to $0.80 in the evening. This may seem insignificant, but the raison d'être of a stablecoin is to track the price of the asset to which it is indexed. By losing parity, it no longer serves any purpose, which is more than problematic for the 3rd largest stablecoin on the planet...
UST price:
What happened? To understand this, we need to go back to 7 May, when massive withdrawals of USTs were observed from the Anchor lending platform. Several billion dollars worth of UST were then sent to the decentralised exchange Curve, which specialises in stablecoin trading. The aim? To sell all these USTs on the markets. The immediate result of this operation was that the balance of a liquidity pool was affected by too many USTs in circulation, causing it to lose its peg to the dollar.
Unlike centralised stablecoins (such as the USDT and USDC), whose parity is ensured by dollar reserves in a bank account, the UST is based on an algorithmic mechanism. When there are too many USTs in relation to demand, the price falls. The value of the UST can therefore theoretically fall to zero if there is too much supply.
⚡️It is for this reason that an arbitrage mechanism has been put in place to ensure its parity with the dollar.
When the UST falls below one dollar, holders can burn their UST to obtain one dollar of LUNA (regardless of the UST's price), the utility cryptocurrency of the Terra blockchain. This reduces the supply of USTs available and helps to stabilise its price. Conversely, when the UST price is higher than the dollar, users can burn LUNA to obtain USTs. Got it? Except that this beautiful mechanism has seized up...
Massive exchanges on the Curve platform caused the UST to fall, sending it below the 1 dollar mark. As a result, other people began to take advantage of the arbitrage to burn USTs against LUNAs in a bid to sell the latter. The scale of the movements prevented the UST from recovering against the dollar as the Luna price collapsed. In the space of a week, the latter lost 65% of its value, despite being one of the star cryptos of recent months!
The Luna Foundation Guard, the Singaporean structure responsible for ensuring that UST parity is maintained, raised $1.5 billion at the start of the week by pledging its bitcoin reserve as collateral, but this emergency rescue was apparently not enough. According to US media outlet The Block, on Tuesday the foundation asked several funds for help in raising a further billion dollars to recapitalise UST. Potential saviours could benefit from half-price LUNA tokens with the obligation to hold them for at least two years.
It's pretty clear that we are witnessing a crisis of confidence in the third-largest stablecoin on the market. We have to consider the possibility that it may never be regained, but the consequences could be contained. UST is only rarely used in decentralised finance with the exception of the Anchor application and a few liquidity pools on Curve (but their weight has largely fallen with the events).
So we can put off the risk of contagion, at least in the short term. But what about afterwards? Especially as this affair has not come at the best of times... The markets are fragile and the slightest spark can set things alight. One more piece of bad news like this and Bitcoin would have no trouble breaking the $30,000 support on which investors' eyes are feverishly fixed.
Article produced with the participation of Artem Sinyakin ( OAK Invest)
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This analysis is not investment advice. It has been prepared without taking into account your personal situation, particularly your financial situation, risk profile, and investment objectives.
