Crypto market is trying to recover after the last turbulent week. However, current rebound of crypto prices should not be a reason for unreasonable optimism as the current setup for the market suggest the existing downside sentiment to continue. Bitcoin may continue to dove to $20,000, while other cryptocurrencies may lose at least 50% of their current prices as the largest trading volumes were recorded at lower price levels. For example DOT was traded most actively at $5.4, SAND – at $0.7, AVAX- at $17.2 etc.
The bearish driver remains the same as investors consider crypto assets too risky amid global geopolitical tensions, fears over stagflation and market liquidity withdrawal by central banks. Regardant investors may notice the correlation between stocks and crypto market. Thus, global factors are weighing on cryptos too. But, the Terra case is quite different and were interesting to discover by crypto enthusiasts.
In short, the prices of native token LUNA and stablecoin UST crashed last week dealing a severe damage to many cryptocurrency holders. The project was particular vulnerable to its internal structure that many other crypto projects have too. An algorithmic stablecoin for Terra ecosystem (UST) was not backed by the U.S. Dollar or Dollar-backed securities, but by LUNA. To maintain price equilibrium of both assets the algorithm burns $1 of LUNA once one UST is minted and vice versa. However, cryptocurrencies are much more volatile compared to traditional fiat currencies. Anchor Protocol, which is behind minting and burning process, gradually increased staking yields, up to 20% annually, which is quite insane for the Dollar and its equivalents. The protocol has locked over 70% of the total UST by the end of April, and started to slash the yields. These actions led investors to withdraw their capital from the stablecoin UST. The protocol allocation of UST dropped from 14 billion on May 6 to 11.7 billion on May 8.
There are two ways investor can get rid of the UST. First is to simultaneously burn UST and mint $1 LUNA. Thus, when many investors rushed to get LUNA the network experienced severe failures and crypto exchanges were forced to stop any UST withdrawals. This announcement together with the overall bearish sentiment ignited panic and a massive sell-offs of UST. The protocol continued to mint LUNA devaluing this cryptocurrency. Therefore, the problems of one asset spilled over to another making both assets suffer.
The other way is to sell UST via Curve Finance liquidity pools. The pricing within the pool is automatic. Once UST is added the USDT is removed for the respective amount. The proportion is changing making a price of UST to fall. Massive UST inflows made arbitrageurs that were involved in such operation unable to clear this situation resulting a plunge of the LUNA from $60 to $0.0002, and UST from $1 to $0.1 within a few days.
The crash of the LUNA and UST would hardly undermine traditional stablecoins like USDT, BUSD and USDC, but would certainly make investors more cautious to crypto projects not backed by safe and reliable assets.