Terra’s native token, LUNA, since yesterday has plummeted about 10% to $65.80 on fears that Terra’s stablecoin UST, propped up mainly by LUNA, may lose its peg.
Stablecoins are cryptocurrencies pegged to fiat currencies such as the U.S. dollar on a 1:1 basis. Depegging refers to stablecoins going above $1 or, more commonly, below $1.
UST fell as low as $0.985 on Saturday, and it’s now trading for $0.99. Although a 1% depeg from $1 isn’t unusual for stablecoins at times of intense market pressure, the parity is often restored quickly. In the case of UST, it’s been more than 16 hours.
Some critics say this highlights UST as a liability for the wider cryptocurrency market as the Luna Foundation Guard, the organization that backs UST, has $3.5 billion in bitcoin ready to sell as a last resort should it need to defend UST’s stability. LFG reserves are in BTC (93%), LUNA (3.5%), and AVAX (3.5%).
The pressure on UST began to mount after the past few days saw high-volume withdrawals from Terra’s Anchor Protocol, where UST deposits currently earn investors 18.8% APY. Although it’s unclear what led to the withdrawals, it could be the bearish turn in the broader market.
Massive withdrawals from Anchor Protocol past hour, frequency increasing
There’s only $300MM left of exit liquidity left on pool 53 before BTC peg
Hope this isn’t how it starts — on a low liquidity weekend pic.twitter.com/BYrhSHtRkI
— Resonance (@resonancethis) May 7, 2022
In what appears to be a domino effect, UST liquidity pool on the Curve shows an imbalance of around 67% at the time of this writing (normally there’s a 50% split). Curve is the main protocol for stablecoin liquidity on Ethereum and highly prized for its deep liquidity, which normally allows traders to swap stablecoins like UST and USDC with extremely low “slippage,” or price difference before and after trade. Since Curve’s so central to DeFi, any sign of irregularity in its pools causes alarm.
Tyler Reynolds, a Web3 investor who closely follows stablecoins, told Decrypt the concerns over Curve’s UST imbalance are “overblown.”
“But it’s kind of like a vending machine. It’s difficult to topple, but once it gets going, no one can stop it,” he said.
Curve’s pool optimization researcher, who goes by the pseudonym nagaking, told Decrypt that in his view “an imbalance like that is not really worrisome.” He explained that the bonding curves of Curve pools are designed such that “they take on some imbalance before shifting the price too much.”
“From the [liquidity pool] perspective, there’s only really a problem if the pool never reverts to near 50/50 balance, corresponding to 1:1 price. So, imbalance per se isn’t an issue, but as the pool becomes more imbalanced and prices deviate further from 1:1, one obviously becomes more concerned that price/pool balance may not revert to normalcy,” nagaking told Decrypt.
Although Curve’s pools are able to absorb such imbalances, the panic among investors yesterday led to large selloffs of UST, mainly to buy other stablecoins, such as USDC.
In what was the largest UST sell-off, Curve Whale Watching, a bot that monitors and tweets large amounts of swaps, showed an 85 million UST swap for 84.5 million USDC. The trader paid nearly $34,000 in fees to the liquidity pool.
Reynolds told Decrypt that there are also second-hand reports of “people converting LUNA to UST and then selling to USDC/USDT.”
Traders swapping LUNA for UST is how UST maintains its stability: The system is designed such that 1 UST can be exchanged for 1 dollar’s worth of LUNA at any time.
When UST dropped below its $1 peg yesterday, arbitragers swooped in and traded LUNA for that discounted UST, generating a profit. This mechanism helps maintain UST’s peg to USD because each time traders buy UST and swap it for LUNA, the Terra protocol removes that UST from circulation. The buy pressure on UST helps maintain its peg.
But the sell pressure on Terra means its price could tank in an effort to rescue its native network’s stablecoin, as was seen Saturday. Moreover, traders taking advantage of UST’s stability mechanism by selling LUNA for UST undermine the peg when they sell large amounts of UST for other stablecoins like USDC, as this brings back destabilizing sell pressure on UST.
Since UST’s peg requires defending through LUNA sacrifices, some traders are so bearish that they’ll bet millions of dollars on LUNA’s price remaining low (defined as below $88) by March 2023.
Lunatics, as the ardent Terra ecosystem supporters are known, saw the recent events that led up to UST falling and continuing to remain at $0.99 as a conspiracy against UST.
today’s attack on Terra-Luna-UST was deliberate and coordinated. Massive 285m UST dump on Curve and Binance by a single player followed by massive shorts on Luna and hundreds of twitter posts. Pure staging. The project is bothering someone. 🌝 on the right path!
— Caetano Manfrini 🔺🌖 (@CaetanoManfrini) May 8, 2022
“Today’s attack on Terra-Luna-UST was deliberate and coordinated. Massive 285m UST dump on Curve and Binance by a single player followed by massive shorts on Luna and hundreds of twitter posts,” Caetano Manfrini, legal officer for Brazilian crypto business consortium GEMMA Ecosystem, wrote on Twitter. “Pure staging. The project is bothering someone. On the right path!”
Meanwhile, the CEO and founder of Terraform Labs, the firm behind Terra, Do Kwon, has downplayed the market panic.
“So, is this $UST depeg in the room with us right now?,” Kwon tweeted Saturday, with a cartoon of a psychiatrist bear attached. “No? I prescribe 24 hours of pegging over the next 7 days,” he said, possibly using a double entendre for a sexual practice. That’s one way of giving the middle finger to UST’s critics.
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