UST Struggles to Maintain Peg as LUNA, Crypto Markets Crash

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Joel Frank

Mon, May 9, 2022, 3:27 AM 4 min read

Key Points

UST lost its peg to the US dollar over the weekend amid large withdrawals from the Terra ecosystem.
The stablecoin’s de-pegging comes against the backdrop of bearish market conditions.
The Terra blockchain’s native token LUNA has come under heavy selling pressure as a result.

Terra USD (UST), the Terra blockchain’s flagship US dollar-pegged algorithmic stablecoin, is facing its first major test since its developer Terraform Labs (TFL) and associated support foundation Luna Foundation Guard (LFG) started building a bitcoin (BTC) and avalanche reserve.

UST fell as low as $0.985 on Saturday, its worst de-peg since January, and has since failed to reclaim the $1.0 level. On Monday in early European trade, UST/USD is trading around $0.994.

On Monday, the LFG announced that it would be loaning out $750 million worth of bitcoin and $750 million worth of UST to trading firms in order to help protect the peg. Do Kwon, the founder of TFL, said the move was aimed at increasing liquidity around the UST peg.

UST’s de-pegging comes against the backdrop of extremely bearish conditions in the broader cryptocurrency market, as well as unfavorable money flows within the Terra ecosystem.

Crypto market pain

Cryptocurrency markets crashed in the latter half of last week. After reaching highs above $1.8 trillion on Wednesday and Thursday, the total market capitalization of major cryptocurrencies has fallen to around $1.5 trillion as of this Monday, a more than 15% drop in just five days.

Over the same time period, bitcoin has cratered from highs last week around $40,000 to current levels in the mid-$33,000s and is eyeing lows of the year just under $33,000. Crypto analysts are saying a return to sub-$30,000 levels looks likely.

Concerns about the response of major global central banks to elevated inflation (i.e. higher interest rates), a weakening global growth outlook plus concerns about geopolitics have weighed heavily on US and global equities in recent weeks.

Cryptocurrency markets currently have a close correlation to equities, hence the recent bearishness.

Trouble in the Terra ecosystem

Turning to unfavorable flows within the Terra ecosystem; the Anchor Protocol, the largest decentralized finance (DeFi) protocol on Terra’s ecosystem that offers UST depositors an attractive yield, saw large withdrawals over the weekend.

Last Friday, deposits were as high as $14.09 billion (most of UST’s $18.6 billion market cap). As of Monday, that has dropped to below $12 billion.

Crypto analysts also cited significant withdrawals from UST liquidity pools on the popular decentralized exchange Curve, as well as pointing to some wallets dumping large amounts of UST.

LUNA worries

Capital flight out of UST and its subsequent de-pegging from the US dollar has exerted significant downwards pressure on the Terra blockchain’s native token LUNA.

LUNA/USD was trading in the upper $80s per token as recently as midway through last week but is now probing $60, a more than 30% drop in five days.

LUNA/USD is now trading substantially below its 200-day Moving Average for the first time in 2022 (the level had provided strong support before), with the cryptocurrency having lost nearly 50% of its value since printing all-time highs near $120 per token back in early April.

Crypto analysts explained that LUNA’s underperformance versus the rest of the crypto market can largely be explained by its linkage to UST via a mint-burn mechanism.

UST seeks to maintain its peg by providing incentives to arbitrageurs. If UST rises above $1.0 due to strong demand, traders can swap exactly $1.0 worth of LUNA for UST, which they could theoretically immediately sell for actual USD, thus profiting immediately from the arbitrage.

Conversely, when UST supply rises, pushing it below $1.0, traders can use the peg mechanism to swap UST for exactly $1.0 worth of LUNA, thus, reducing the supply of UST. Then, if they want, they can immediately sell the LUNA and pocket the difference.

Herein lies the problem for LUNA. The longer UST remains de-pegged and the more it de-pegs to the downside versus the US dollar, the more pressure LUNA will come under as arbitrageurs seek to make a quick buck.

This article was originally posted on FX Empire