UST stablecoin is no longer 'stable': Here's what you should know

One of the most popular stablecoins, TerraUSD (UST), is no longer stable.

Within the past few days, UST has lost its peg to the US dollar twice and has since dropped as low as US$0.6923 (S$0.96) at the time of writing.

The stablecoin’s market capitalisation dropped from about US$18 billion to as low as US$12.6 billion.

So, what caused TerraUSD’s de-pegging and what does it mean for cryptocurrency investors?

Read on to find out!

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TL;DR: UST Stablecoin has lost its peg to US dollar

• A massive sell-off was triggered when UST was first de-pegged, causing the price of UST to drop as low as US$0.6923
• The Luna Foundation Guard is now deploying loads of money in the form of Bitcoin and other cryptocurrencies in order to restore UST’s peg
• The de-pegging of UST and other macroeconomic factors have caused the crypto market to fall across the board

What is Terra and TerraUSD?

For the uninitiated, this is what Terraform Labs, the company behind Terra, describes it to be: "Terra is a public blockchain protocol deploying a suite of algorithmic decentralised stablecoins which underpin a thriving ecosystem that brings DeFi to the masses."

FYI: Stablecoins are a category of cryptocurrencies that try and peg their market value to an external asset like fiat currencies, precious metals or other cryptocurrencies in a bid to stabilise the price.

Terra’s main product is TerraUSD (UST), which is an algorithmic stablecoin that is pegged to the US dollar, i.e. 1 UST = US$1.

TerraUSD (UST) Tokenomics

To understand how Terra maintains this peg, let’s look at the tokenomics of UST.

The price of UST is maintained by creating and destroying supply through a swap with another token called LUNA.

In essence, Terra depends heavily on users to maintain UST’s peg.

This is eerily similar to Iron Finance which depends on the TITAN token to maintain IRON’s peg.

The price of TITAN fell from US$64.04 on June 16, 2021 to almost zero (US$0.00000105) on June 17, 2021.

Unlike Iron Finance however, Terra has a faster oracle (system) in place that allows UST to quickly recover from peg losses, and more significant use-cases for LUNA as opposed to TITAN.

As another "safety net", there is an organisation called the Luna Foundation Guard (LFG) that acts as a second layer of protection from UST de-pegging by lending out money.

Lastly, UST’s utility lies mainly in Anchor Protocol, a money market where you can borrow or lend UST, which helps keep its price stable.

For investors, the big upside to Anchor Protocol is that it offers a whopping ~18.97 per cent APY on the amount of UST staked.

UST de-pegging

This whole incident started when two large transactions were made that sold UST on the open market.

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The first large transaction of US$150 million worth of UST was made by Terraform Labs, which was used to deploy into a new pool. This transaction caused a reduction of liquidity in Curve, a stablecoin trading platform.

Seemingly to take advantage of the reduced liquidity, an unknown actor then made another large transaction of US$84 million by selling UST for Ethereum.

Some people have claimed that this could be an "attack" with the intention of destabilising UST and possibly profiting from it.

Economics suggests that when supply exceeds demand, there will be downward pressure on price.

With a sudden surge of UST supply, this was exactly what happened as UST dropped.

Despite the initial attempts by LFG however, UST dropped under US$0.99.

When this happened, a massive sell-off was triggered as the crypto market started sweating due to fear, uncertainty and doubt (FUD in crypto slang).

With many liquidating their UST from Anchor Protocol or pulling out from LUNA, the supply of UST surged further, which caused the price to nose dive.

As of today (May 11), the price of UST has gone back up to US$0.8037 (as at 9.22am, May 11, 2022), with LFG using Bitcoin and other cryptocurrencies to buy up UST.

Afterthoughts

Whether you are bullish or bearish about Terra, UST and LUNA, one thing is for sure, the crypto market is currently going through some rough times.

Coupled with macroeconomic factors, this has caused cryptocurrencies across the board to drop by more than 10per cent in price.

As for UST’s price, it can really go either way.

If users continue to sell-off to the extent that LFG does not have enough money to cover, UST and LUNA could potentially drop to zero.

On the other hand, UST’s peg can be restored once LFG and the crypto market buys enough UST to return its supply back to normal.

Want to share your thoughts about UST’s de-pegging? Head on over to the Seedly Community to share your opinions.

This article was first published in Seedly.