At the beginning of May 2022, LUNA traded at $80 but is currently down to 0.00012. As per Coin Market Cap data, it has wiped about $28 billion of investors’ money from the market. Some investors are already wailing, and Binance has suspended the trading of LUNA. And the LUNA tokens do not show any signs of rebounding soon.
What happened, you ask? Will LUNA rebound? Before examining its probability of rebounding, let’s understand how LUNA works.
What is LUNA
LUNA is a native cryptocurrency to the Terra ecosystem developed by South Korean Terra Labs. It aims to be a peer-to-peer cash system without hidden fees. The Terra ecosystem enables developers to create custom blockchains and dApps on its blockchain. Currently, the blockchain hosts a myriad of NFTs, web 3 apps, and Defi platforms.
Connection With UST
To understand how and what caused the LUNA crash, it is imperative that we understand the connection between LUNA and UST. UST is an algorithmic stablecoin pegged on the US dollar. In simpler words, one UST should be equal to a dollar. To learn more about stablecoins and how they work, find a more detailed exploration about stablecoins here.
UST maintains its peg by burning LUNA tokens. Put differently, minting UST requires burning LUNA tokens of equal value. The whole process is tied to arbitrage. When UST exceeds $1, you can always exchange it for $1 of LUNA tokens making a profit. Similarly, if UST falls below $1, you always exchange it for $1 of LUNA, making a profit. Now, this self-regulating mechanism is what maintains the peg.
But could anything possibly go wrong?
What Caused The Crash
Primarily, the LUNA crashed when the UST coin lost its peg. The problem was triggered by the Fed’s unexpected increase in interest rates. As a result, UST investors went short on the stablecoin, and its value dipped. Investors would receive more LUNA for UST prompting the bear to sell-off. Remember, the crypto market is already bearish. Bitcoin and Ethereum have lost almost 50% of their value from their all-time high.
The algorithm had to react to correct the situation. However, investors were also shorting LUNA. This led to a crisis as the algorithm created more LUNA tokens to meet the supply. The supply increased seismically from 700 million to about 7 trillion in a week. A case that could be best explained by hyperinflations. As a result, the LUNA value tanked by 99%.
Lack of collateral, save for the value associated with UST, compounded the crisis. Terraform labs and the LUNA foundation bought Bitcoin worth $1.5 billion to collateralize LUNA, meaning that only 10% of the asset is collateralized. They eventually sold off the Bitcoin, which increased negative sentiment.
The question lingering in the mind of many investors is whether this “crypto winter” will end. The interest rates hike to curb the soaring inflation in the west has only made matters worse. Lamentation on a devoted subreddit perhaps casts a glance on the happenings, with some people admitting to potential home loss.
Will LUNA Recover
LUNA has made an official communication on Twitter that the postmortem of the week’s occurrences is finalized and will be availed to investors soon. Remember, the total locked value of the DEFI on the LUNA blockchain hit $31 billion in April. It was only second to the Ether, which had $122.73 billion. However, the value has declined to $1, sliding siding to 11th place.
Terra labs CEO Do Kwon, a software engineer formerly at Microsoft and Apple, has opined the only pathway to dealing with the problem is absorbing the UST supply. Luckily there are various methods to increase minting capacity for faster absorption. The CEO expects the supply to decrease due to various reasons such as burn rate and peg pressure.
According to the company, the plan is to deal with bad debt. The foundation has proposed burning the remaining UST tokens held by the community and staking LUNA to prevent attacks on the network.
Although Terra’s main message is to encourage investors to exercise patience, the developer has identified three approaches that could potentially turn around the situation.
- The first prong approach is to burn all the remaining 371 million UST tokens on the Ethereum network.
- Secondly, the blockchain network will be looking to burn UST on the Terra community pool.
- The last approach is to stake 240 million LUNA tokens to stabilize governance and help prevent whales from absolute control of the market.
A Recovery is Possible
LUNA seems like it has hit a dead end and many investor who invested in the coin decided to rather return back to trade Bitcoin, as the safer option. With this being said, we can’t overrule a possible comeback. Currently, the ecosystem has stopped the completion of unsettled transactions. Therefore, users cannot take advantage of the LUNA floor rates and scoop all of them. To crown all, the community has a plan to boost the UST burn rate. The team’s great inventions have catapulted the Defi platforms with the highest TVL. However, it’s quite likely they will find a way around the problem