Crypto
market is trying to recover after the last turbulent week. However, current
rebound of crypto prices should not be a reason for unreasonable optimism as
the current setup for the market suggest the existing downside sentiment to
continue. Bitcoin may continue to dove to $20,000, while other cryptocurrencies
may lose at least 50% of their current prices as the largest trading volumes were
recorded at lower price levels. For example DOT was traded most actively at $5.4,
SAND – at $0.7, AVAX- at $17.2 etc.
The bearish
driver remains the same as investors consider crypto assets too risky amid
global geopolitical tensions, fears over stagflation and market liquidity
withdrawal by central banks. Regardant investors may notice the correlation
between stocks and crypto market. Thus, global factors are weighing on cryptos
too. But, the Terra case is quite different and were interesting to discover by
crypto enthusiasts.
In short,
the prices of native token LUNA and stablecoin UST crashed last week dealing a severe
damage to many cryptocurrency holders. The project was particular vulnerable to
its internal structure that many other crypto projects have too. An algorithmic
stablecoin for Terra ecosystem (UST) was not backed by the U.S. Dollar or
Dollar-backed securities, but by LUNA. To maintain price equilibrium of
both assets the algorithm burns $1 of LUNA once one UST is minted and vice versa.
However, cryptocurrencies are much more volatile compared to traditional fiat
currencies. Anchor Protocol, which is behind minting and burning process, gradually
increased staking yields, up to 20% annually, which is quite insane for the
Dollar and its equivalents. The protocol has locked over 70% of the total UST
by the end of April, and started to slash the yields. These actions led investors
to withdraw their capital from the stablecoin UST. The protocol allocation of
UST dropped from 14 billion on May 6 to 11.7 billion on May 8.
There are
two ways investor can get rid of the UST. First is to simultaneously burn UST
and mint $1 LUNA. Thus, when many investors rushed to get LUNA the network
experienced severe failures and crypto exchanges were forced to stop any UST
withdrawals. This announcement together with the overall bearish sentiment
ignited panic and a massive sell-offs of UST. The protocol continued to mint
LUNA devaluing this cryptocurrency. Therefore, the problems of one asset
spilled over to another making both assets suffer.
The other
way is to sell UST via Curve Finance liquidity pools. The pricing within the
pool is automatic. Once UST is added the USDT is removed for the respective amount.
The proportion is changing making a price of UST to fall. Massive UST inflows
made arbitrageurs that were involved in such operation unable to clear this situation
resulting a plunge of the LUNA from $60 to $0.0002, and UST from $1 to $0.1
within a few days.
The crash
of the LUNA and UST would hardly undermine traditional stablecoins like USDT,
BUSD and USDC, but would certainly make investors more cautious to crypto
projects not backed by safe and reliable assets.