Stablecoin UST loses its peg to the US dollar amid the collapse of the crypto market

Against the background of the collapse of the cryptocurrency market, the algorithmic stablecoin of the Terra ecosystem – TerraUSD (UST) – again lost its peg to the US dollar. On the night of May 10, the price of the asset fell below $0.62 (Coinbase).

Due to the incident, cryptocurrency exchange Binance temporarily froze withdrawals on the Terra blockchain. Users drew attention to the empty order book of the platform.

At the time of writing, UST is trading near $0.91.

UST/USD hourly chart on Coinbase. Data: Trading View.

TerraUSD is one of the largest dollar stablecoins. According to CoinGecko, its capitalization exceeds $16 billion. Since the burning mechanism of the native cryptocurrency LUNA is used to issue UST, the price of the two assets is closely correlated.

“The presence of such a relationship creates significant inflationary risks that arise when stablecoins are withdrawn from the Terra ecosystem. Such a review of market processes shows that the withdrawal of a significant amount of UST from circulation does not affect the value of the latter due to arbitrageurs, however, the operation stimulates a decrease in the price of LUNA. In the context of a downtrend in the market and in the presence of negative news, a significant drop in the value of the cryptocurrency can be observed, ”Sergey Strutinsky, a specialist in the field of mathematical modeling and a regular ForkLog contributor, shared his opinion.

Over the past 24 hours, LUNA has lost over 40% of its value and is trading near $36 at the time of writing. Back on Friday, May 6, the price of the cryptocurrency exceeded $80.

LUNA/USDT hourly chart on Binance exchange. Data: Trading View.

The UST parity model with the US dollar relies heavily on arbitrageurs. If the price of a stablecoin falls below $1, traders can buy it and exchange it for $1 in LUNA, making a profit

However, for this mechanism to work, it is necessary to ensure the demand for the target asset. In the case of UST, the platform that provides such demand is the largest protocol of the Terra ecosystem – Anchor. The latter pays more than 19% per annum on a deposit in UST.

According to SmartStake, users withdrew over 3.3 billion UST from the protocol on May 9. For less than a day on May 10, the outflow of funds amounted to another 1.1 billion UST.

Data: SmartStake.

Users withdrew funds due to a decrease in the deposit rate to 17.87%. On May 8, this led to a brief loss of UST peg to the US dollar. But already on May 9, the indicator returned to 20% – against the background of the outflow of funds from Anchor, it became easier to pay a higher percentage.

At the same time, the protocol’s yield reserve continues to shrink. At the time of writing, there are less than 180 million UST in the pool.

Data: SmartStake.

In March 2022, UST added another resiliency mechanism, the Luna Foundation Guard (LFG) bitcoin reserve fund. It must promptly provide the liquidity in BTC necessary to maintain the price of the asset. Already in May, the volume of assets under management of the structure reached 80,394 BTC.

Aztec project growth head Jonathan Wu noted that the decision to create the fund was made after the incident with the Abracadabra Money platform. The latter allowed UST to be used to issue Magic Internet Money (MIM) with a collateral ratio of up to 90%.

In January 2022, a scandal erupted around the Wonderland DeFi project, with which the founder of Abracadabra Money, Daniele Sestagalli, is associated. The incident led to a decrease in the value of LUNA (the cryptocurrency quotes fell by 21% over the week) and a temporary loss of UST’s peg to the US dollar.

Amid the events of May 9th, LFG announced that it will provide a $1.5 billion loan to OTC traders to ensure the sustainability of TerraUSD. Funding was allocated through the sale of reserves in BTC.

Shortly thereafter, the organization published its new bitcoin address and noted that it would continue to provide loans to market makers.

On-chain data shows LFG’s wallet is empty. According to the organization’s dashboard, ~$197 million of assets remained in the reserve fund – the lion’s share of the funds falls on LUNA, UST and AVAX.

Data: LFG.

Jose María Macedo, a member of the LFG Governing Council, stressed in a conversation with CoinDesk that there will be enough reserve funds to restore a stable UST price. However, critics of the organization believe that it has only “bought another day of time”.

The Block analyst Larry Cermak noted rumors that Jump Crypto, Alameda Research and other organizations supporting the Terra ecosystem have allocated an additional $2 billion “to save UST.” In his opinion, the only way to save an asset is to make it fully secured.

The head of Terraform Labs, Do Kwon, emphasized that LFG has no plans to “give up its positions in bitcoin.” He explained that the transfer of capital to market makers would provide liquidity that would allow UST to stabilize.

Jonathan Wu also suggested that trading companies are “ready to do everything to prevent the UST death spiral”. According to him, the outcome of the situation will depend on whether the pressure of market makers will exceed selling from retail traders.

Popular analyst Hasu noted that Terraform Labs and LFG had a different possible strategy.

“I don’t want to tip Ponzi, but I would just let the peg collapse rather than burn the treasury trying to save it. Wait until the UST supply hits Treasury parity and then recover the asset as a backed stablecoin,” he wrote.

Meanwhile, Terraform Labs said that skeptics exaggerate the significance of what is happening. The company emphasized that UST is also provided with activity within the Terra ecosystem, and arbitrageurs need time to stabilize the asset.

Some believe that the incident, regardless of the outcome, will have serious consequences for the cryptocurrency market. Blogger Dennis Porter noted that regulators will use the collapse of the UST as the main argument in favor of total regulation of stablecoins.

Recall that in a recent ForkLog exclusive, he told how Anchor problems can bring down the Terra economy and the cryptocurrency market.

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