Terra Bets the House on a New Fork as the Zero-bound LUNA Coin Can’t Resurrect the UST Stablecoin

Rohail Saleem

This is not investment advice. The author has no position in any of the stocks mentioned. Wccftech.com has a disclosure and ethics policy.

Terra (LUNA), a public blockchain protocol that powers a number of non-collateralized stablecoins, will be long remembered for unleashing the crypto sphere's first "Lehman" moment as the whale-sized volatility quakes and the corresponding contagion emanating from TerraUSD (UST) losing its $1 peg spread to virtually every corner of the market, hammering Bitcoin and causing Tether to briefly lose its peg.

Before delving into the details of this crisis, let's go over a quick refresher course. Terra maintained UST's $1 peg by algorithmically adjusting the supply of UST and LUNA. If the price of UST fell below $1, the supply of UST was burnt by minting $1 worth of LUNA, entailing a swap fee that was paid in LUNA coin. This reduced UST's supply and allowed the peg to be restored. On the other hand, if the price of UST exceeded $1, LUNA was burnt to mint $1 worth of UST, entailing a swap fee paid in UST, thus increasing the stablecoin's supply and reducing its price. These swap fees played an important role in funding staking rewards. Moreover, the swap fee tolerance determined the amount of LUNA/UST that could be burnt or minted at a given time. Check out this Twitter thread for more details on this topic:

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With this primer out of the way, let's go over what went wrong. Terra's algorithmic approach toward stablecoins worked relatively well during periods of low volatility. However, it has utterly failed in the face of heightened volatility. As documented in the thread below, the crisis began with an $85 million swap between UST and USD Coin (USDC).

From that point onward, Terra's LUNA coin slowly fell into a death spiral. About a week back, LUNA's price was hovering around $73. At that point, if you redeemed/burnt 1 UST, you would get 0.059 LUNA coins ($1 worth). However, as LUNA's price plunged to $0.1 on the 12th of May, burning 1 UST would get you 10 LUNA coins. This dynamic illustrates how the supply of the LUNA coin increased drastically over the past week, resulting in a hyperinflationary death spiral. Toward the start of this crisis, LUNA's supply was 386 million coins. At the time of writing, the supply is hovering at 6.53 trillion coins!

Of course, during the early phase of the crisis, Terra's LFG Council loaned Bitcoin worth $750 million to OTC traders in order to try to restore the peg. However, this attempt also failed. Perversely, the measure introduced additional volatility into Bitcoin's ecosystem, causing its price to plunge below December 2020 lows on Thursday. The volatility quake also briefly de-pegged Tether.

So, what happens next? Tether's Do Kwon is now championing a fork initiative under the Terra Ecosystem Revival Plan:

  • Reset the network ownership to 1 billion tokens
  • Of this new supply, 400 million tokens are to be given to previous holders of the LUNA coin
  • Another 400 million tokens are to be given to UST holders on a pro-rata basis
  • The residual 200 million tokens are to be divided between a community pool and those who tried to save LUNA during the terminal phase of the crisis

Of course, a lot of people believe that the Terra brand has become just too tarnished for a wholesome revival now:

Currently, Terra's UST is trading at around $0.20 price level, far below its $1 peg.

Source: https://coinmarketcap.com/currencies/terrausd/

And LUNA is trading at $0.0004631, a price level reminiscent of meme coins such as Shiba Inu.

Source: https://coinmarketcap.com/currencies/terra-luna/

Finally, this crisis now poses grave implications for the entire stablecoin universe, with the regulatory hammer now much more likely to drop in the coming days.

Do you think Terra's fall from grace will have a lasting impact on the entire crypto sphere? Let us know your thoughts in the comments section below.

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