The crypto market has been through many steep drawdowns in previous cycles, but what’s happening now with the Luna ecosystem is something we have never seen before. What used to be a top ten cryptocurrency with over $40 billion market cap has now fallen to a 590 million market cap, with the token (LUNA) price trading under $1.
That is more than 97% of the value wiped out of the Luna ecosystem. And it all happened in a matter of a few weeks. The root cause behind this crisis is UST deviation. As Terra stablecoin is algorithmic, investors lost confidence in its stability when it failed to repeg multiple times, leading to a death spiral.
UST losing its peg also reflected in the deposits on Anchor protocol. Many investors deposited money on Anchor, hoping to get a risk-free 19.5% annual yield. In one year, the circulating supply of UST went from $2 billion to $18.5 billion. But after recent events, investors aggressively took back their money, crashing the total deposit value from $14 billion to $4.6 billion in three days.
In order to restore the peg, the Luna Foundation Guard decided to loan $1.5 billion in equal amounts of BTC and UST to OTC trading firms. They expected this to stabilize the UST value, as traders would deploy capital on both market sides. You can check the transactions of their reserve wallet here.
As the price of BTC continued to go down, the price of UST followed. This is one of the reasons why people were cautious when Do Kwon decided to use volatile assets like Bitcoin and Avalanche to be a part of UST reserves. The money left in reserves cannot be directly connected to the smart contract to automatically inject capital and stabilize UST value, as the onchain dex developed by the Astroport team is still weeks away from a testnet launch.
As a consequence of UST de-pegging, we see investors leverage Luna and UST’s price arbitrage. As we know, $1 UST is burned to mint $1 worth of Luna. The same applies the other way around as well. So traders are buying UST for less than one dollar and swapping it with Luna that is worth one dollar. As a result, the price deviation is their profit. For example, if I buy 50 cents of UST and use it to mint Luna, I would get $1 worth of luna, which gives me 50 cents of profit. Because of this constant absorption of UST supply, the selling pressure on Luna is mounting rapidly.
This brings us to our initial question: should you bet on Luna moving forward?
The fundamentals of Luna have changed over this year, from burning Luna to mint UST to using bitcoin reserves to keep the peg stable. Now, if the Luna ecosystem wants to recover from this tragic event, it first needs to stabilize UST.
But that’s not possible with current capital available. So other entities in the community, probably VCs and crypto hedge funds, have to enter and bail out Luna. Once UST restores, the underlying mechanisms will change and become fully collateralized, according to Do Kwon. If everything is handled properly and Luna makes a strong recovery, then buying a small amount of tokens at these prices could be massive in two to three years. You should also remember that prices could go down even more. So only invest if you can afford to lose.
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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