ViaBTC Capital|The Collapse of LUNA


Timeline of the collapse:

-In the early morning of May 8, in preparation for the 4Crv Pool, Luna Foundation Guard (LFG), a Singapore-based nonprofit that maintains the Terra network, removed $150 million worth of UST from the UST-3Crv Pool . At the time, the pool’s TVL was approximately $700 million. In other words, it only took about $300 million to empty this pool.

– To maintain the liquidity balance in the UST-3Crv pool, LFG has removed an additional $100 million worth of UST from the pool.

– On the evening of May 8, WhaleTrades, a whale warning account on Twitter, started frantically “ringing alarm bells”: There was a tweet selling millions of dollars to UST every hour.

– On the morning of May 10, Jump Trading and LFG may have sensed the problem and stopped selling their Bitcoin holdings to provide support for the peg of UST, putting things in limbo. As a result, UST plunged all the way to $0.6.

– On May 11, UST appeared to be shorted by Soros-style shortsellers, falling to as low as $0.2998 (source: CMC) after rounds of undercutting.

It was a terrifying day on May 11: There seemed to be short sellers deliberately shorting UST and LUNA:

– While liquidity is being drawn from the UST-3Crv pool as reserves for the 4Crv pool, a single wallet dumped $350 million worth of UST on Curve, causing UST to lose its peg to the US dollar. In response, LFG sold BTC to keep the peg, then the shortseller dumped the rest of UST on Binance.

– UST was severely depegged, followed by a run on UST. LFG then came to the rescue with a plan to lend large amounts of BTC, but caused a nosedive in BTC. Since new LUNA is minted by burning UST, the stock of LUNA has instead increased, leading to a slump.

– The profit from short positions of BTC and LUNA from the short seller is estimated to be more than $1 billion, and the cost, mainly the dumped UST, is estimated to be less than $200 million.

Impact on the LUNA ecosystem

Given the close relationship between projects in the Terra ecosystem and LUNA and UST, as well as DeFi Legos’ reinvestments and profits, the UST depegging dealt a heavy blow to both the LUNA-margined and UST-margined staking, DeFi, lending, margin , and other protocols and prices. Worse, it even led directly to the liquidation of protocols, sending LUNA and UST into a secondary death spiral.

1. Anchor

As a decentralized savings protocol built on the Terra ecosystem, Anchor has a stable APY of 20%, which is its most notable feature.

Driven by UST depegging, Anchor’s APY rests at 18.9%, but total deposits plummeted to $3.99 billion from $14 billion last Friday, as suggested by Anchor’s Dashboard.

Complementing the Anchor and Terra ecosystems, Orion.Money is designed to facilitate the conversion of other stablecoins such as USDT and DAI to UST for revenue from savings in the Anchor ecosystem. In particular, investors invest ORION and enjoy significant returns with APYs of 10%, 15% and 20%. With the UST depegging, stablecoin bets on the Orion protocol have fallen by more than 50%.

2. Mirror

The synthetic assets in Mirror are all minted with UST as the main collateral to mirror various financial assets like stocks and ETFs. Therefore, the investment demand for US equity-based synthetic assets in Mirror will eventually turn into the demand for UST, which creates the main use case for this stablecoin and provides value for UST and LUNA.

The Terra chain’s TVL on Mirror fell from $600 million to $240 million, a 60% drop.

3. Turn off lido and node

Lido, the largest liquid stakeout protocol, already kicked off the Liquid Staking for Terra plan last year, releasing the LUNA deployed by nodes in the Terra ecosystem. The LUNA deployed on Lido also witnessed a decline of about 60% and frenetic undercutting. As a result, the TVL of Terra’s strike in Lido fell 80% on May 11 alone, dropping a staggering 91% in seven days.

On the other hand, stopping nodes directly affects the authentication and security of the Terra network. So far, we haven’t seen a large number of nodes fleeing yet. Given the UST depegging, more and more LUNA will come into circulation, pushing the supply towards 1 billion.

4. Abracadabra

Abracadabra launched the Degenbox UST strategy. Users deposit UST tokens into the cauldron to either borrow MIM or leverage their position, greatly improving returns. As long as UST stays at $1, this strategy is basically risk-free. However, once UST is depegged, users risk liquidations if their collateral declines in value.

Currently, the Abracadabra protocol is moving all UST from the UST strategy on Terra back to Ethereum in response to current market conditions. It pays more attention to liquidity and possible liquidations.

Relevant reserve pools

As for the death spiral facing algorithmic stablecoins earlier this year, LFG has created a reserve pool of Bitcoin and AVAX to support the value peg of the stablecoin UST.

Using BTC as an example, let’s take a closer look at this mechanism: LFG was originally intended to alleviate inflationary pressures using BTC. When traders exchange UST in the chain for LUNA, it reduces the new stock of LUNA to contain the death spiral and make the whole system more resilient to risk. Under the on-chain mechanism proposed by Jump, 1 UST can be exchanged for $0.98 worth of BTC. If the UST price is below $0.98 for off-chain transactions, traders can buy Bitcoin from the reserve at a discount. Such a variant of the AMM mechanism is called “The Defender”. Before the supply price of UST exceeds $0.98, the reserve pool is the best place to buy Bitcoin in the market. This mechanism provides a hard support for the pin of the UST.

Neither BTC nor AVAX will be used as collateral. In fact, taking into account the fragility of algorithmic stablecoins, such a new mechanism was designed to link the coins to more stable assets, which do indeed hedge to some extent against sale. Despite the clever design, UST/LUNA cannot be exchanged for bitcoin on the chain for the time being. Worse yet, as UST struggles to keep its $1 pin, LUNA holders suffer a breach of trust and find themselves trapped in a deadly spiral.

LFG was forced to dive into its bitcoin stack to back the token. According to the report, LFG has lent $1.3 billion in BTC (28,205 bitcoins) to trading firms to hold UST’s price peg. But that was just a drop in the ocean. Rising interest rates and contraction in the balance sheet announced on 10 May have made matters worse. As the consistent influx of established financial institutions into the crypto market in recent years has brought Bitcoin much closer to the US stock market, Bitcoin fell below $30,000 in response to the collapse of US stocks and LFG’s large lending to bitcoin.

AVAX is another ecosystem closely related to Terra. Do Kwon announced on April 8 that AVAX will be used to provide reserve against UST, and crypto users will be able to stock UST on Avalanche. This is an effort to add more use cases of UST through the many AVAX powered projects. Meanwhile, the Avalanche ecosystem also needs its own stablecoin, which made the two click right away. However, this seemingly perfect partnership also has its pitfalls. Similar to that of BTC we mentioned earlier, the working principle of AVAX and UST is to form a virtual AMM pool where users who have earned UST on Avalanche’s C-Chain can exchange $1 worth of AVAX for $1 worth of UST or $1 worth of UST in 99 cents at AVAX. It should be noted that this asymmetric arbitration design is only used when UST falls.

Fortunately, AVAX cannot currently be used directly to mint UST. The AVAX reserve announced by Do Kwon only covers the 100 million AVAX acquired by LFG, a transaction that will be transacted through the Avalanche Foundation in an over-the-counter (OTC) manner. Details (e.g. existence of a lock-up period and specific price) of the deal remain unknown to the public. Compared to LUNA’s nearly 99% decline, AVAX, which declined more than 20% in value due to general market effects, has not been much affected. At the same time, the meltdown sounded alarm for the entire public chain. Do all ecosystems need a stablecoin? NEAR, which launched its ecosystem-based stablecoin USN during its childhood, was more affected than AVAX, and the loss of market confidence led to a downfall.

Other Algorithmic Stable Coins

The crisis of confidence in stablecoins caused by the collapse of UST has spread to other stablecoin protocols, but this is also a good opportunity to test users’ confidence in other protocols and their underlying mechanisms.

No traces of large-scale depegging have been observed in decentralized stablecoins (except fiat-collateralized USDC, USDT, TUSD, etc.) before or after the collapse of UST (with the depegging threshold set at 5%). One exception is HARD Protocol’s USDX, which saw a decline of about 8%. Even those partially collateralised, such as FEI and FRAX, have not undergone severe depegging.

Unfortunately, UST has destroyed market confidence in stablecoins, especially in those algorithmic stablecoins and stablecoin protocols that are not fully collateralized, such as FXS and SPELL.

Dynamics:

According to some sources, LUNA’s meltdown could have been the brains of HF Citadel Securities, suggesting that this famous Wall Street player throttled the market by lending 100,000 bitcoins, crushing LUNA’s peg mechanism and resulting in a vicious spiral.

Do Kwon first sought help and tried to raise $1 billion by selling LUNA at a 50% discount, but the proposal was rejected.

He then announced proposal 1164, which was passed with 35 votes in favor and 4 abstentions. The main purpose of the proposal is to accelerate the combustion of UST. More specifically, it will increase the base pool from $50 million to $100 million in SDR and reduce the Pool Recovery Block from 36 to 18 blocks, increasing UST’s coin capacity from $293 million to $1.2 billion.

At Terra, a Korean company focused on fintech and payments, huge traditional funds from many major Korean companies are stored in the form of UST. Such assets will have legal consequences. Compared to LUNA, which mainly affects crypto investors, UST needs more money from non-crypto communities. By comparison, such funds come with greater responsibilities and more demanding legal requirements. If you are asked to choose only one of the two, LUNA will certainly be given up to ensure the value of UST. If external financing cannot be relied upon, the only way to continue using LUNA is to burn UST and convert LUNA into more valuable assets (BTC/USDT), stabilizing the UST peg. The stabilization of the UST link through the continued exploitation of LUNA’s value is the only viable way to save UST. As such, the LUNA price may continue to fall until the tragedy ends with the help of outside financing.

In short, LUNA has fallen off its pedestal.

At the time of writing, the price of LUNA is $0.8 and the UST price is $0.68.

*The above cannot be used as investment advice.

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