Why is Luna drowning?

Good morning! Welcome to The Daily Moon. It’s a brand new week and we want to start you off with an explainer on what’s really going on with Luna and UST. Last week was crazy. So here we are, breaking it down for you.

Terra’s de-peg debacle

A complete wipeout happened in just 24 hours. Terra’s LUNA saw its prices nosedive 99.9% on May 13. So much so that the Terra blockchain had to halt mining for nine hours before resuming again. Following this, global and Indian exchanges delisted LUNA.

Now, as LUNA was falling, TerraUSD was falling too. From a level of 1 TerraUSD being equal to $1, it fell to 0.20 levels. As crypto investors were scrambling for answers, this dip was blamed on something called ‘de-pegging’. This just meant that TerraUSD, which walked hand-in-hand with the US Dollar, was now lagging behind.

Losing the peg

Before we proceed, there are some basics that you’ll need to understand about stablecoins, one of which is TerraUSD.

• Stablecoins are pegged or linked to a stable asset such as the US Dollar. Pegging means that the coin is equal to the value of the asset.

• Compared to other crypto assets, stablecoins are ‘stable’ because they are linked to a government-backed instrument.

• Stablecoins are still digital assets, offering the privacy of a decentralised system.

The Terra ecosystem offers two coins to the crypto market. The first is LUNA, and the second is the stablecoin UST. Both ‌coins are very essential to each other’s functioning, given that their inter-conversions fuel the entire LUNA system.

The interconnectedness can be tricky, too, because if one falls, the other follows.

Usually, stablecoins maintain the needed value steadiness by pegging their price levels to the value of a currency or a commodity. So, for instance, you have USDC and Tether, which actually have physical dollar reserves as backing. That means for every 1 USDC issued, there is $1 present as an underlying.

In Terra’s case, that wasn’t the reality. And this is where things get complicated.

The algo puzzle

TerraUSD does not have an actual stock of US dollars to back the stablecoin. Instead, it follows an algorithm that is intended to automatically stabilise the price of the stablecoin. This was done by making TerraUSD and LUNA operate like twins.

To simplify:

1. TerraUSD runs parallel with LUNA. So if there are too few TerraUSD stablecoins in the system, the algorithm will trigger the mining of new LUNA. So more coins are released.

2. Now say there are too many coins. The algorithm will step in and launch a ‘burn’ to remove some LUNA coins.

3. Every time one TerraUSD is bought, one LUNA is burnt. And when one TerraUSD is sold, one LUNA is minted.

This constant churn ‌has kept the TerraUSD and LUNA stable. So whenever TerraUSD inches below $1 levels, more LUNA coins are burned so that the stablecoin’s supply becomes scarce. This eventually leads to the price levelling back to the $1 peg.

And ‌if TerraUSD is on the verge of surpassing $1, more LUNA coins are created or minted. If market demand is constantly met, the coins stay stable.

Monday mayhem

On May 9, there was a mass dumping of TerraUSD coins into the crypto ecosystem. These coins were suddenly in excess supply.

Intriguingly, there were a series of withdrawals at the lending market: Anchor Protocol. As a result, Anchor’s total TerraUSD deposits fell from $14 billion to $11.2 billion. Withdrawing TerraUSD in bulk meant that the market had more coins than it could absorb.

To break it down:

• TerraUSD was dumped back into the market, causing excess supply.

• Mass selling was initiated, which meant more LUNA would be minted.

As a result, LUNA’s supply skyrocketed to the extent that its value was reduced to less than a penny, or just about $0.00003863.

Here’s where things get weird

Mysteriously, one crypto wallet sold $84 million worth of TerraUSD on Ethereum. Additionally, $108 million of TerraUSD was also dumped in Binance's exchange. Given the sudden and massive nature of the junking, some call this de-pegging debacle a ‘coordinated attack’.

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Who are we? There is a lot happening in our world. Everything has layers, and each layer has to be carefully peeled so you, the reader, know how the world of money is changing every day. That’s our promise. Help you unpeel the onions, which are the public markets in the US, India, and crypto, so that you know just a little more.