Luna, the crypto that is meant to stabelize the UST dollar token, has collapsed, falling 93% in just a few days down to $2 from a high of $120.
“The last 72 hours have been extremely tough,” said Do Kwon, Luna’s founder. “I am resolved to weather this crisis.”
The UST “stable” coin itself was down 70% at one point to 30 cent from its supposed $1. It now trades at 44 cent in the biggest collapse of a stablecoin since their invention in 2015.
“The price stabilization mechanism is absorbing UST supply (over 10% of total supply), but the cost of absorbing so much stablecoins at the same time has stretched out the on-chain swap spread to 40%, and Luna price has diminished dramatically absorbing the arbs.
Before anything else, the only path forward will be to absorb the stablecoin supply that wants to exit before $UST can start to repeg. There is no way around it,” Do Kwon said.
Unlike most stablecoins, this one allows for a minting both ways. You burn Luna to mint UST, and vice versa, by burning UST you mint – create from nothing – Luna tokens.
At the right time, like this week, to attack this peg you mass burn your UST position – some $285 million of it back when it was actually worth nearly 300 million in dollars – flood the Luna supply in the process, short Luna as its price will fall due to demand and supply, and then keep shorting as a downward spiral kicks in.
To stabilize this, there’s a minting fee mechanism where UST is taken for the Luna reserve if Luna is used to mint UST, and Luna is taken if UST is used to mint Luna. Some of the supply that increases is thus taken out in fees.
So now they’re just increasing that minting fee to raise the amount that is burned with a proposal set to pass stating:
“Starting from May 9th to May 10th 2022, about $8B UST were withdrawn from Anchor Protocol ($14B.- $6B = $8B).
During the same period, only ~$1B UST were burned.
With slow recovery of UST price, the market is losing confidence of UST peg, where traders and speculators keep pushing both UST de-peg, and push down LUNA price in an aggressive way.
Traders and speculators are taking advantage of the information that UST peg restoration will burn billions more UST and mint billions more LUNA.
Traders are front running and selling/shorting more LUNA and pushing LUNA price down. When the UST Mint/Burn peg trades eventually happens, these Mint/Burn will happen at a worse price, resulting more-than-necessary LUNA being minted.
To address this front running, and to protect Terra/Luna Ecosystem, here is to propose increase of BasePool size and decrease of recovery block, to increase total daily minting capacity 4x.”
The problem however might be that Luna’s market cap is now just $1 billion, while UST’s market cap is $7 billion.
So the peg may well return after playing with parameters, but $39 billion has been wiped out in Luna, and $10 billion has vanished in UST.
That’s $40 billion gone out of $46 billion, with the question now being whether a return of the peg even matters.
Because it’s not too clear why Luna would have any demand moving forward with its design appearing to be that of a 100x leverage.
Most other stablecoins have a fixed design where the supply of the dollar token might increase or decrease depending on demand, but the total supply of eth doesn’t move based on DAI, and the total supply of USD does not, in theory in any event, move based on what USDt or USDc is doing.
This mechanism where both ends of the peg move depending on the demand for each, is probably far too complex to keep in balance.
The closest to it might be Synthetic, but even there the supply of SNX does not move depending on mints. A lot of other parameters move, like sUSD or sAPPL, but the anchor itself does not move in its own supply.
Its price does of course change, but that sets the responsibility to the individual, who just gets margin called.
Here the responsibility appears to fall on the crypto itself, and as we are seeing that crypto, Luna, has just gotten margin called.
That’s for the first time in crypto history that we see such event, with UST being very new, launching in November 2020.
It has clearly grown too fast, perhaps because until recently when Do Kwon started buying bitcoin with Luna reserves, no one was paying attention to it.
For this sort of new mechanism, investors or holders would usually be warned to go very slowly as the mechanism has to prove itself.
It took years for DAI for example to reach $1 billion in market cap with a smart contract based limit imposed on it, initially of $100 million, a limit that was raised slowly.
UST, despite being unproven, went off to nearly $20 billion in just a year, and as quickly as it rose now comes crashing with it clearly not withstanding the test of time as Luna has collapsed.
Whatever is revived here therefore, may well be just for the corners as if anyone wants to continue or re-start this experiment in a proper manner, there have to be limits for the mechanism to prove itself.
As far as the wider stablecoin space is concerned, UST is clearly not a real stablecoin as it has not proven itself, and thus has nothing to do with the wider stablecoins space as it’s clearly not even a stablecoin.
Where cryptos more widely are concerned, or bitcoin, this collapse establishes that you can’t get away with unsound mechanisms in a fixed money crypto environment for long.
Fed should be happy however as this design could have come straight from St. Luis, but is the design of USD really much different? Both the dollar supply and its anchor, bonds or taxes, move. So the dollar has collapsed too, but over decades.
Which means this is good for bitcoin, because in the open source space your weakness will be a feast, with crypto so showing itself to be ‘objective’ as there is a fixed unit of measurement.
In the dollar world instead, this sort of mechanism might have continued for long and they might have even called it a commercial bank.
