Chronicles of the LUNA/UST collapse, the largest in crypto history
A bit of context, how it happened, and what it means...
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What a week.
We have seen projects fall before. But this magnitude of sudden collapse is really unprecedented in the history of crypto.
Witnessing what feels like a real life episode of Game of Thrones, I can’t help but change my content calendar and take a stab at summarizing this serie of events for you all.
The TLDR is… we are seeing a historic collapse of LUNA and UST, which are native assets of Terra, one of the major Layer 1 blockchains in the crypto space.
LUNA and UST both made it to the top 10 cryptocurrencies by market cap recently, and their fall in just 3 days represented around $50B in capital loss.
How the hell did this happen, you ask? Well… let’s dive into it.
Context first for those readers who are unfamiliar with the subject.
If you already know this, please jump to the next section directly.
Now, there are 2 things you need to understand in order to properly get what is happening:
The Terra ecosystem: UST and LUNA dynamic.
What a Stablecoin is.
So bear with me:
Terra was one of the largest layer 1 blockchain.
It was founded in 2018 by Do Kwon under Terraform Labs.
LUNA is Terra’s native coin.
Terra also has a series of native Stablecoins, with UST being the main one.
Now, Stablecoins are cryptocurrencies that are “stable” in price, without the typical volatility. They play a significant role as this stability allows them to provide the function of money the way we know it.
Typically, the mechanism to maintain the price at 1:1 with the USD is through pegging its value to a different asset: the most common case is to peg it to real world currency like the US Dollar itself. This is the case for USDT, USDC, BUSD, etc.
But this is not the only way. There are also algorithmic stablecoins that seek to maintain its peg to the USD by the use of algorithms. The OG in this space is DAI built by MakerDao.
So UST built by Terra belongs to this latter category: it is an algorithmic stablecoin that maintains its pegged via incentives. It is connected to the main coin LUNA, and uses a mint and burn mechanism to maintain the price, meaning when one is minted, the equivalent amount is burnt, and vice versa.
Therefore, UST and LUNA are correlated assets that are not just linked by the same blockchain ecosystem, but also by a share dynamic in prices, which explains why they collapsed together.
If you wanna read more, here are the full articles:
The Build Up
From the 2021 bull market till now, we’ve seen exponential institutional investment coming into crypto, so the demand for stablecoins skyrocketed.
The leading stablecoin Tether (USDT) has always faced questions regarding how much USD they have in their reserve, so as people were searching for an alternative, UST presented itself as a pretty good novel option backed by one of the largest L1 blockchains.
Not a surprise, confidence in UST grew together with the massive amount of money flowing in.
Now, add Anchor Protocol to the equation: this is one of Terra’s main protocols that’s offering a 20% APY in UST. Terra was very vocal about the fact that this subsidized yield was part of their marketing strategy, and a bunch of retail investors like myself was incentivized enough to deposit UST.
Fast forward a few months, UST had a market cap of $36 billion, with $14 billion locked in Anchor at its peak.
LUNA, on the other hand, reached an all time high of over $116 this year.
But within a matter of 3 days, all hell let loose.
UST lost its peg, big time, reaching a bottom of $0.34, so far.
LUNA went on free fall thanks to its redemption mechanism, the fear sell, and the desperate attempt to restore UST’s peg. At the time of this article, it is literally at $0.058 cents.
Just think about it: from $116 to $0.058 cents, it’s practically a 100% lost in its value.
This is a roughly $50 billion of total capital destruction out of the LUNA ecosystem: largest collapse in crypto history:
LUNA went from $41 Billion to $300K market cap.
UST goes from 18.7B dollars to 5.2B dollars.
And counting.
How did it all happen?
Here comes the meaty part, like a GoT wedding…
Some say it is a coordinated attack. Attack or not, it’s coordinated for sure, and it’s someone with deep pockets to make a move of this magnitude.
For the sake of making it easier to narrate the events, I’ll go on calling this person/entity the “attacker”.
***Disclaimer! I’m attempting at summarizing how things happened to the best of my knowledge. If I got any facts wrong, do let me know! Appreciate it.
Now, let’s look at how the key events unfolded.
1. Getting the ducks in a row
Late March this year, LFG (Luna Foundation Guard) purchased over $1 Billion worth of BTC to back the UST peg, trying a similar approach to how countries buy gold or other foreign assets to keep in their reserve.
It seems that the attacker was part of those who sold BTC to Do Kwon, so in exchange he got a bunch of UST in his pocket.
2. The targeted timing
Without going into details, a big amoung of UST had to be withdrawn from one place to another (the 3 Pool to 4 Pool migartion) on the Curve pools.
Thanks to this liquidity removal, the UST peg was shaky, and this is exactly when the attack happened: the attacker, who held a massive amount of UST, started selling into the Curve pools, destabalizing the peg.
3. The chain reaction
Because of this, Luna is forced to defend by selling BTC, but this is money losing also as the price of BTC was lower than purchased price. Also, this got the whole crypto market affected given the fluctuations on BTC.
At this point, funds and large players that are keepign an eye and more savy in this type of games, foresaw that there is no enough liquidity for everyone, so they started seeling as well.
And voilà, the attacker successfully turned the intentional depegging into a massive “bank run”, generating a negative feedback loop.
This then triggered LUNA to go on free fall.
Panick increased in the overall crypto market which clearly didn’t help.
And on, and on.
And here we are, witnessing the sudden death of one of the key players in the industry.
The worse part? we don’t even know how much worse it can get.
What does this all mean?
The biggest concern across the crypto world are related to the second and third order consequences…
All those pools and funds that were related to LUNA and UST going bankrupt…
Impact on the overall sentiment of the crypto market. It’s a sea of red right now…
Regulatory backlash that we might face as an industry…
So stay tunned to how this unfolds.
……………..
Now, going back to the whole sh*tshow, whether this was a coordinated attack or just a rational trade to exploit an opportunity to make a massive amount of money (walking away with around $900M), ultimately it doesn’t matter.
What matters is, if it can be attacked, then it will be attacked.
And we are not just talking about large institutional money.
We have people’s jobs depending on it, and people’s lives savings poured into it.
So as part of the overall crypto community, we all have to do a better job at growing and scaling this space in a more responsible and sustainable way.
Lastly, let this not scare you away from crypto, there is a bunch of great stuff happening.
Even if you got burnt (like myself, small confesion to my readers), hang in there. Let’s all keep learning and educating ourselves. This is still one of the greatest opportunities in our generation.
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