Terra’s stablecoin UST, the poster child for decentralized assets tied to the US dollar, rebounded sharply on Tuesday as it climbed as high as $0.92 after plunging 40% below its dollar peg, to $0.60, on Monday.
The blockchain’s native LUNA remains in free-fall, having lost half its value in the last 24 hours as of mid-morning trading London time.
UST has been the most successful example of an algorithmic stablecoin, or a stable asset which depends on an internal algorithm that manages its supply and demand to maintain its peg. Developers have tried to create these self-regulating assets for years, with many crashing and burning along the way.
In Terra’s case, 1 UST can always be redeemed for $1 worth of LUNA. This mechanism incentivizes arbitrageurs to buy UST when it trades under $1, redeem it for $1 worth of LUNA, and sell the LUNA for a profit. Conversely, when UST trades above $1, investors can mint 1 UST with $1 worth of LUNA and sell the UST for a profit.
A crisis of confidence has ensnared UST as investors are exiting their holdings en masse.
UST traded as low as 60 cents on the dollar on Monday with nearly $3B in trading volume on the centralized exchange Binance alone.
Deposits on Anchor have fallen by half since Friday from $14B to $7B.
At the time, Terra brushed off concerns, but the market wasn’t so sure as LUNA, the token backing UST, started to deepen its slide.
The steady depletion of liquidity from the UST Curve pool as users swapped UST for other stablecoins can be seen in this Dune dashboard.
LFG Steps In With $1.5B
Earlier today, the Luna Foundation Guard (LFG) deployed $1.5B of its reserves in an attempt to defend the UST peg. According to the project, $750M worth of Bitcoin and $750M have been loaned to market makers to support peg restoration efforts.
Despite these moves, investors began to panic after the market capitalization of LUNA fell below that of UST just after 1pm Eastern time, meaning there is simply not enough value in LUNA to back all the UST in circulation, not considering the recently constructed LFG reserve.
What does that mean? If the circulating UST is worth more than the market cap of LUNA, it’s not possible for all UST holders to redeem their tokens for $1 worth of LUNA if they wish to. The resulting stampede for the exits is the dreaded ‘bank run’ scenario that has laid waste to numerous algorithmic stablecoins including the infamous implosion of Iron Finance last year.
The last time this happened was in May 2021, and UST briefly de-pegged before recovering.
On a bloody day in crypto markets, Terra also came under fire for allegedly selling Bitcoin and Ether and compounding a bad situation.
Risk To Crypto
“UST was always a systematic risk for crypto. If the peg is not restored through natural demand LFG needs to tap into their reserves to prop it up themselves by selling BTC and buying UST,” crypto trader Cantering Clark told The Defiant.
Terra says that its ‘A-Team’ has been assembled to spearhead a recovery.
Owen Fernau contributed reporting.
UPDATE @ 5/10 6AM ET: This story was updated to reflect UST’s overnight rebound.