This month saw the value of Terra (LUNA) plummet from US$80.3 to US$0.0001702 and TerraUSD (UST)‘s price fall from US$1 to US$0.10.
The rapid drop in prices of these two currencies has been dubbed the “LUNA Crash” by experts as well as crypto community members. While the event’s name only focuses on one coin, it’s important to note that these two assets’ fates were interconnected.
So, why did the values of Terra (LUNA) and TerraUSD (UST) crash? And how did TerraUSD (UST) cause the price of Luna to go down?
Before we move forward, let’s find out the difference between TerraUSD (UST) and Terra (LUNA) below.
TerraUSD (UST) vs. Terra (LUNA): What’s the difference?
TerraUSD (UST) and Terra (LUNA) are two original tokens from the Terra network, a blockchain project developed by Terra Labs in South Korea. Until now, the Terra ecosystem has developed more than 100 projects, including Non-Fungible Tokens (NFT) and Web 3.0 applications.
Established by Do Kwon, a Stanford University computer science graduate, the Terra blockchain’s tokens were minted as stablecoins and stablecoin facilitators.
Stablecoin: A currency token with stable price, or equal to that of a certain fiat currency.
Stablecoins’ values are supposed to match with a fiat currency. A 1-to-1 price match is said to support a global payment system with a stable price as well as provide a quick and affordable completion process.
We also have a multitude of different coins including Bitcoin Cash (BCH), Cardano (ADA), Decentraland (MANA), Bitcoin (BTC), Ethereum (ETH), NEAR Protocol (NEAR) and Litecoin (LTC) offered at the best prices and lowest spread.
What is LUNA?
Terra (LUNA) is a crypto asset created to keep TerraUSD’s prices level.
This crypto asset has no maximum supply quantity as its supply always follows the amount of Terra stablecoins being circulated. Even so, the supply of LUNA will keep decreasing because it is consistently burned, and “converted” into a Terra stablecoin.
The burning mechanism is said to make LUNA’s value continually increase.
See more: LUNA Price Prediction 2022
What is UST?
TerraUSD (UST) is an algorithmic stablecoin derived from the Terra blockchain network.
The currency’s mechanisms are a little different from other stablecoins such as USDT and USDC. Namely, TerraUSD (UST) is not supported by USD or other fiat currencies.
On the contrary, this crypto asset uses Terra (LUNA) to stabilize its price at US$1 by burning LUNA to generate new UST tokens.
1-to-1 swap guarantee
In Terra’s ecosystem, users can swap LUNA tokens with UST and vice versa, with a 1-to-1 price guarantee. This is regardless of the current market price between the two tokens at the time.
This means that if the demand for UST increases, and its price also rises over US$1, then LUNA holders will profit from trading LUNA worth US$1 to one TerraUSD token.
The swapped LUNA is taken out of circulation and stored in reserve. The funds in the treasury are then used to invest in applications and services to expand the Terra ecosystem’s utility.
The process of burning the LUNA token itself will reduce the overall remaining tokens in circulation, thus making the price go up. On the other hand, generating more UST tokens will increase the supply of circulating tokens and make the overall price return to US$1.
Similarly, if the demand for UST is low and the price decreases to under US$1, UST holders can trade their UST tokens with a 1:1 ratio for LUNA.
So, why did Terra (LUNA) and TerraUSD (UST) crash?
With all these mechanisms in place, you may be wondering, why did Terra (LUNA) crash? Or how did TerraUSD (UST) cause the price of LUNA to crash? Here is the explanation.
Quoting Financial Express, the decrease in the price of Terra (LUNA) is linked to the large-scale selling of LUNA tokens caused by the failure in de-pegging UST.
As explained before, TerraUSD (UST) is backed by a cryptocurrency called LUNA. You have to first burn LUNA to be able to generate UST and vice versa.
This system is designed to utilize supply and demand. So, if the demand for UST drops and its value falls behind that of USD, those who profit from market inefficiency will sell LUNA so that the value of UST can be successfully recovered.
The mechanism that supports the price of UST is semi-automatic and works well most of the time, even when many volatilities are happening. Even so, this scenario does not go well in extreme cases, like the one happening right now.
In the second week of May, the TerraUSD (UST) price gradually decreased. Quoting Business Today, the shrinking of the UST price curve could have been caused by a reaction to the devaluation of the dollar.
According to them, when the dollar value fell from US$1 to US$0.68 on 9 May 2022, investors either liquidated their UST or opted for other stablecoins as TerraUSD was trading at a price below its USD value. Furthermore, LUNA plummeted as a result of large-scale short-selling.
This analysis is supported by Jennifer Lu, one of the founders of Coinstore. Jennifer said that the value of UST, which fell to the level of US$0.60 a few days ago has successfully triggered a large-scale sell-off and caused the crash in the price of LUNA.
A bearish market worsens LUNA’s decline
Meanwhile, Anshul Dhir, the COO and Co-founder of EasyFi Network, through Financial Express, also explained that this sell-off is further worsened by the bear market conditions.
Caused by the ongoing Terra (LUNA) issue, through its official Twitter account, the Terra Blockchain has been officially halted at a block height of 7,603,700.
Block height: The total number of blocks in a blockchain.
Furthermore, Terra validators have decided to stop the Terra chain to prevent a governance attack after the LUNA inflation that kept on worsening and significantly reduced the cost of attack.
UST vs USDT vs USDC, what’s the difference?
When talking about stablecoin, it seems unfair if we only discuss the UST. Did you know that there are other well-known stablecoins, which are USDT and USDC?
Here’s a brief overview.
See more: All You Need To Know About USDT & USDC
Tether (USDT)
Tether (USDT) is one of the well-known stablecoins in the world, which is issued by Tether Limited.
USDT is designed so that its value has a 1:1 ratio to the US Dollar. This means that while the price of other crypto assets are fluctuating, the price of USDT will usually remain around US$1.
At the time of writing, USDT is ranked third on CoinMarketCap site with a market cap of US$80.5 billion.
As the most popular stablecoin, USDT operates on several prestigious blockchains, such as Ethereum (ETH), Algorand (ALGO), EOS, Solana (SOL), Tron (TRX), and many more.
Tether claims that its asset is supported by cash reserve, unsecured short-term debt, and other USD-denominated fixed-income securities.
The price of USDT to USD as of the time of writing is US$0.99.
USD Coin (USDC)
USD Coin (USDC) is a stablecoin that launched in 2018 and is supported by the Centre Consortium – led by Coinbase and Circle.
As of the time of writing, USDC is valued at US$1.
Same with USDT, USDC has also been implemented in several networks, including Ethereum, Avalanche (AVAX), Algorand, Solana, Hedera Hashgraph (HBAR), Tron, Stellar (XLM), and many more.
According to the developers, each USDC is backed by US$1 or assets with a similar value that is stored in a US financial institution account.
TerraUSD (UST)
Meanwhile, different from Tether (USDT) and USD Coin (USDC), TerraUSD (UST) is a decentralized algorithmic stablecoin that operates on the Terra (LUNA) blockchain.
The founder of TerraUSD is Do Kwan. This crypto asset was launched in 2020 and designed to provide stablecoin solutions for decentralized finance (DeFi) fans.
However, unlike a centered stablecoin, UST is not supported by USD reserves in a bank account. In return, to generate a UST token, users will have to pay for a LUNA worth 1 USD, which acts as a TerraUSD reserve asset.
Besides that, the TerraUSD Anchor protocol also offers a yield of up to 20% on the UST deposit.
The price of TerraUSD (UST) to USD as of the time of writing is US$0.07135.
Stablecoins in a volatile market
The popularity of stablecoins is very likely linked to the fact that its value remains relatively stable compared to other crypto assets.
While cryptocurrencies are considered valuable assets, it’s also important to know that the market is notoriously volatile. So, we’d like to stress how crucial it is to do your research before investing in any asset.
To get to know the market a little more, check out our Learn page. We have guides ranging from how to read crypto charts, mining setups, coin information and even a glossary.
