The repercussions of UST losing its peg have caused a market-wide meltdown, sending the entire crypto market capitalization to March 2020 levels. Bitcoin has broken a key support region at $30,000, which has tremendously spread panic all over the crypto markets. Due to the extreme volatility and sell-off of crypto assets, today was observed to be the highest volume day in crypto history, standing at $255 billion.
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Considering macro uncertainties, most of us knew crypto was in a dicey situation with a heavy downside. But what happened in the past few days is that the collapse of UST and the overall Terra ecosystem accelerated the capitulation phase, sending us into a likely prolonged bear cycle that could last at least 1-2 years.
Many market participants have compared what’s happening with UST and Luna to the 08′ financial crisis caused by the collapse of Lehman Brothers. Similar to how Lehman Brothers heavily accumulated mortgage-backed securities for their portfolio, the Luna foundation added bitcoin to its reserve for backing their algorithmic stablecoin UST. The applicability of both asset classes is different, but they had a similar impact on the price of the stock or token in the case of Luna.
The assets in the Lehman portfolio were so bad that no one was ready to bail them out. Similarly, in the crypto space, no one seems to be coming forward to restore the peg of UST by injecting the required capital. For comparison, Almeda is considered Warren Buffet, and Jump Crypto wears the AIG hat in this whole UST fiasco.
What Will It Take to Make a Recovery?
Out of all the cryptocurrencies, the ones that have gone through multiple cycles and are considered “time-tested” by broader market participants are Bitcoin and Ethereum. They have recovered nicely over the previous cycles, making new all-time highs. But that doesn’t apply to the newly emerging projects like the Terra protocol.
In the case of Terra, the concept of algorithmic stablecoin was fundamentally incorrect. Many well-known leaders and builders in this space, like Sam Bankman-Fried and Vitalik Buterin, have also expressed concerns with stablecoins that are not properly collateralized or use volatile assets in reserves. In a recent interview with Bloomberg, Sam said that algorithmic stablecoins backed by highly volatile assets like Bitcoin would move in relative motion. So if Bitcoin goes down, UST stablecoin also follows.
To overcome this, Do Kwon and the Terra community plan to change the mechanism to be fully collateralized. Before they can get there, UST has to restore its peg. They have released new proposals, highlighting a burn of 371 million will commence on Ethereum, and 240 million Luna tokens will be staked to defend against governance attacks.
It is crucial that they stop the bleeding for Luna. As more and more UST is burned, the supply of Luna goes parabolic. In the last four days itself, the supply went from 346 million to 7.1 billion. This rapid spike in supply causes dilution, resulting in a massive price drop. And that’s exactly what happened. Luna’s price has fallen from $63 to less than $0.10 in the same period. So if the Terra protocol wants to make a strong recovery, they need to first bring back the value of UST to $1. This will reduce the selling pressure on Luna, giving them the time required to make modifications to the protocol mechanism.
Nothing is “too big to fail” now
Luna lost nearly $40 billion of market cap in a matter of one week. Its ecosystem had many innovative and well-developed applications that were far superior to other chains. Examples are Edge Protocol, Anchor Protocol, Mars Protocol, Mirror Protocol, and Prism Protocol.
The algorithmic-pegged stablecoin was also considered to be a proven model, and no one expected it to fail. Why? Because everyone thought it was “too big to fail.” But in crypto, a single loophole can be exploited to extents that no one ever imagines. That’s what happened with UST.
Many investors assumed it provided the safest way to make high returns (20% on Anchor) and deposited large sums of money. And now, many of them lost nearly 99% of their money, as they had their tokens locked. In conclusion, this is a humbling reminder to all market participants that we are dealing in an extremely high-risk environment. What may seem safe or low risk, like stablecoins and other blue chips, also carry significant risk when we compare them to other markets.
Born and brought up in India, Karthikeya Gutta is a crypto journalist and freelance contributor for ItsBlockchain. He covers various aspects of the industry with in-depth analysis and research. His passion towards blockchain and crypto ecosystem is mainly because he believes it can really change the world and help millions of people.
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