LUNA and UST investors have been having a rough week.
Terra’s stablecoin UST was supposed to be worth $1 in USD. That’s supposed to be how stablecoins work: cryptocurrency “pegged” to a traditional asset like the USD. Intended as a safe haven in times of crypto hardship. They even have the word stable written right there in the name! But this week, Terra’s UST has been anything but. After losing its peg, UST fell below $0.30 — much to the delight of crypto short sellers.
Its sister coin, LUNA, has fallen even more dramatically. Last Monday, LUNA was trading above $88. At the time of writing, the coin is trading at $2.14 — down more than 97% on the week.
In order to determine exactly what caused the plunge, let’s first identify what separates UST from your traditional dollar-backed stablecoin.
How UST Functions
While many stablecoins, like Tether, have reserves, UST is a little different. Instead of holding a reserve of cash to back its token, UST runs on an algorithm, with an important caveat: its peg is contingent on demand for the Terra ecosystem, which LUNA is an important part of.
That means when people don’t want UST, they can burn it for LUNA, and vice versa.
Vocab check: Burn — When coins are burned, they are permanently pulled from circulation — a deflationary measure. This is usually done by transferring the coins into a “dead wallet”, or one with a private key.
However, with this week’s macro environment reaching fever pitch, demand has fallen drastically, leading the UST peg to collapse as investors rush for the door, cashing out their UST and LUNA at whatever price they can get.
Desperate Times Call for Desperate Measures
In an effort to save the endangered currency, the Luna Foundation Guard (an organization that supports the Terra ecosystem) in collaboration with Terra’s creator Do Kwon offered to lend $1.5B worth of Bitcoin to help get UST back to its peg.
This development has many crypto investors worried that the Luna Foundation Guard might liquidate a large amount of its bitcoin to bolster UST — a development that could prove problematic for the macro crypto landscape. This may be part of why Bitcoin fell below $30,000 on Monday, its lowest value since June 2021.
So far, Do Kwon and the Luna Foundation Guard’s efforts haven’t sent UST back to its peg, but it likely has reduced some of the pressure on the stablecoin.
After dropping below $0.30, UST is currently trading at $0.506.
The Bottom Line
UST and stablecoins are often looked at as a safe-haven for investors to help investors survive stormy macro environments. But this week’s events have proven that no investment can truly be 100% safe — no matter how much research is backing it.
That’s what we preach at Market Rebellion. Whether it’s crypto, options or equities — you need to have a plan for everything, including sudden losses in value. If you need help developing a crypto trading plan, check out Market Rebellion Crypto.
As for UST and LUNA, there’s no telling when, or if, they’ll recover. There’s likely going to be some kind of restructuring, and who knows if that will lead to a complacency bounce or not. But for investors who got burned, trust has been broken. It’s clear that many Terra enthusiasts will be watching this one from the sidelines.