OMG, What Happened To Luna?
Terra Luna crashed last week, Here's a breakdown for all my crypto newbies.
Hello my crypto frenz,
Last week was the most insane week in crypto ever. I’ve been in these crypto streets for 5 years and absolutely nothing tops what happened in the Terra Luna ecosystem.
First, to those of you impacted by the crash of $UST and $LUNA, I’m so sorry. Terra Luna appeared to be a legitimate Layer 1 blockchain ecosystem and losing the value of your assets in that ecosystem has to be devastating.
Now, let's get into it.
According to the bankless newsletter, in the Terra Luna ecosystem, more than $41 billion in value has been destroyed since April 5.
Here are the basics.
Terra Luna is a blockchain protocol that focuses on creating and supporting algorithmic stablecoins. Users flocked to the Terra Luna ecosystem and viewed Anchor (the biggest protocol/app built on top of Luna) as an easy way to earn high yields on their savings account balance.
$Luna is the protocol's native staking token that absorbs the price volatility of Terran($UST). $Luna is also used for governance and in mining.
A little tidbit on governance and mining:
In crypto, some projects are set up so that their community can use tokens to submit proposals and vote on how the project is run and how the project treasury is used.
Mining is a method of verifying transactions on a digital ledger for a blockchain using machines with extensive computing power.
Terra aka $UST is the algorithmic stablecoin that tracks the price of the US Dollar. Users mint (create) new $UST by burning (destroying) $LUNA.
Algorithmic stablecoin: A cryptocurrency that tracks the price of any asset, usually fiat currency. Algorithmic stablecoins maintain their price peg through a set of rules or software instead of an underlying asset.
In contrast, a stablecoin like $USDC is backed by actual US Dollars while $UST is not backed by any type of collateral but controlled by rules of software.
How do $LUNA and $UST (Terra) work together?
The Terra Luna ecosystem relies on market incentives and arbitrage to maintain its peg (fixed price). $UST and $LUNA work together to keep the value of $UST at $1.
Here’s a perfect detailed explanation from Egirl Capital, where it breaks down how Terra Luna relies on arbitrage to maintain the $UST peg to $1.
For the sake of understanding let’s assume that to mint means to create or make new and that to burn means to destroy or deplete.
The price stability of TERRA (UST) is driven by the interaction between these two tokens – users are able to burn LUNA to mint UST, or burn UST to mint LUNA.
To encourage this to happen at the right time, there exists the algorithmic ‘market module’ which always enables 1 USD of LUNA to mint 1 UST (and vice versa), even if the price of UST is under or over $1.
As such, if UST was trading at $1.01, it would be possible to trade $1 of 1 UST and then sell this UST for $1.01 – generating an arbitrage profit of $0.01.
The opposite would happen if UST was trading at $0.99 – 1 UST could be purchased for $0.99 and swapped for $1 of LUNA generating $0.01 or arbitrage profit. Both of these arbitrage mechanisms continue until the price of UST is back at the peg of $1.00.
We learned that arbitrage is one part, another major factor is how Terra Luna uses market incentives that help stabilize and fuel the Terra Luna economy:
The price of $UST is heavily related to the demand to use $UST on any of the decentralized apps in the Terra luna ecosystem.
Let's set the scene…
You just got back from your morning walk, you love taking those now that remote work life is a permanent thing for you. You get back in the house, check the prices and see that your initial $LUNA investment has nearly doubled, you’re up 50%
Instead of cashing out into dollars you decided that you want to let your money sit in a stablecoin and earn yield on your balance.
So you use your Terra Station wallet to swap your $LUNA into $UST, the native stable coin in the Terra Luna blockchain ecosystem.
When you swapped your $LUNA into $UST, the terra luna protocol burned (destroyed) the $LUNA (meaning those $LUNA tokens were no longer in circulation) and minted $UST, meaning you created new $UST tokens and those $UST tokens are equivalent to the worth of your burned Luna in dollars.
Next, you move your newly minted (created) $UST to the Anchor protocol and deposit your $UST where you will receive 20% APY on your balance.
(Anchor is the main lending protocol in the Terra ecosystem where users can get 20% yield on their UST)
Now, say you have a reason to believe that the price of $LUNA may go up and you decide to swap back into $LUNA. You’d use your Terra Station wallet to burn your $UST tokens and mint $LUNA and now you have $LUNA in your wallet.
So, How was $UST depegged?
Depegged: To keep it simple 1 UST does not equal $1 anymore.
Since the beginning of spring, the market cycle has shifted towards bear (downward) sentiment, meaning that prices of the crypto assets are progressively going down over time. The euphoria (of high crypto prices) is gone and people are cashing out.
At this same time, there were actions taken in the market that made market participants (traders, institutions, liquidity providers) lose confidence in the Terra Luna ecosystem. It started with one big $85 Million swap from $UST to $USDC that knocked $UST from its peg. This event caused market participants to lose confidence and start to seek safety, meaning they started to sell their $UST and $LUNA.
Here is how the price tanked:
People in droves start to sell their $UST
This burns $UST and mints more $LUNA
More $LUNA is added to the total circulating supply (making it hyper-inflationary)
This makes LUNA less scarce and drives the price down
People continue to panic and sell LUNA
The rest was a domino effect and at the time of writing this $LUNA is down 97% and at the price of $0.0001603 and $UST is down 75% at the price of $0.15 cent.
(If you want a full play by play, watch this or read this)
Final Thoughts
Crypto is risky. We hear that a lot but this is the first time we’re experiencing the risk en masse. Thousands of people have had their savings wiped out and no one should be rejoicing right now. It’s an L for everyone, even if you weren’t directly impacted by the Terra Luna crash. All we can do is move forward, be more cautious and keep an eye out for the stablecoin regulations that may come as a result of this crash.
So, what do we do next?
We stick together. We learn together. We build together. And we win together.
There’s nothing that we can’t recover from, one day when we look back at this, it will be a bump in the road. If you stick around, continue to learn, you’ll be rewarded. Bear markets are the best time to join communities, make friends and really get an understanding of this crazy movement we call Web 3.
This blog would not be possible without these sources:
Terra Flops, Matt Levine
Algo Stables In a Market Stress, E Girl Capital
UST Luna Meltdown: What Happened? - Ben Giove
Believe it or not, a lot more happened in Web 3 last week.
A typo moves $36M in seized JUNO tokens to the wrong wallet, almost $50 Million in loans nearly crashed on Fantom and IG announced support for NFTs from Ethereum, Polygon, Solana, Flow.
Want to know what else is happening in Web 3? Check out this round up of news articles, new products and learning opportunities.