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LUNA Loses 90% Of Its Value In One Week
By: In: Technology

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LUNA is the native currency of the Terra blockchain, a blockchain protocol that uses fiat-pegged stablecoins to power price-stable global payments systems.

According to its white paper, Terra combines the price stability and wide adoption of fiat currencies with the censorship-resistance of Bitcoin (BTC) and offers fast and affordable settlements.

In the last seven days of trading, LUNA has lost its position as a top 10 cryptocurrency by market capitalization as it currently ranks #28 as of the time of this writing. Its token price traded $87.96 a week ago, to currently stand at $8.81 as of the time of this writing, which represents an approximately 90% decline in just seven days.

The shocking thing about LUNA is that it created an all-time high of $119.18 a little over a month ago and it has lost over 92% since then, making it one of the fast declines in the cryptocurrency space as over $37.4 billion in market capitalization has been whipped off in less than five weeks.

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What is the Terra Blockchain?

Terra seeks to set itself apart through its use of fiat-pegged stablecoins. The platform combines the borderless benefits of cryptocurrencies with the day-to-day price stability of fiat currencies. It keeps its one-to-one peg through an algorithm (using programs) that automatically adjusts stablecoin supply based on its demand. It does so by incentivizing LUNA holders to swap their LUNA tokens for stablecoins at profitable exchange rates, as needed, to either expand or contract the stablecoin supply to match demand.

This was the case when Terra launched its UST stablecoin in September 2020. TerraUSD (UST) is the decentralized and programmable stablecoin of the Terra blockchain. It is a scalable, yield-bearing coin that is value-pegged to the US Dollar.

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TerraUSD was created to deliver value to the Terra community and offer a scalable solution for DeFi amid severe scalability problems faced by other stablecoin leaders like Dai. Thus, TerraUSD promises users a higher level of scalability, interest rate accuracy, and interchain usage.

Where it all went wrong

A major selling point for holding UST is the passive income opportunities that exist. Holders can gain passive income using TerraUSD with the Anchor protocol’s stable interest rates. Anchor protocol is a lending and borrowing protocol built on the Terra blockchain. Even with the massive sell-off we are seeing on the protocol, the platform is still the highest in terms of total value locked (TVL) to the tune of $3.99 billion as of the time of this writing.

Anchor promises a 19.50% return on UST savings. Additional and steady income appears through rewards in PoS chains, which maintain their stability due to commissions and inflation. This nuance will make it possible to form a reliable interest rate, or so we thought.

Ultimately, lenders can deposit their UST, which they redeem by burning their LUNA tokens, which makes the LUNA token scarce and earn attractive rates on their investments while simultaneously benefiting from low volatility. Borrowers can turn their LUNA collateral into productive assets without giving up control of it.

Due to this promise, we saw an astronomical increase in the market capitalization of UST. In fact, UST because the third-largest stablecoin by market capitalization, surpassing Binance’s BUSD. UST got very popular after Terra founder Do Kwon pledged to buy $10 billion worth of Bitcoin to back the programmable stablecoin. So far, the Luna Foundation Guard had bought up over 42,500 BTC to the tune of $3 billion, fulfilling its promise of buying $3 billion in the short run. However, the reality of the economic policies and decisions hit the market in May, causing the crypto market selloff to intensify.

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The U.S. Fed increased interest rate as it handed down its policy decision earlier this month. The Fed hiked its interest rate by 0.50% to 1%, the largest increase since 2000, as it handed down its policy decision. Although Fed Chairman Jerome Powell said the 75-basis points super-hike feared by investors is “not something that the committee is actively considering,” the worrying pressure of inflation, high energy prices and supply chain bottlenecks have caused investors of risker assets to derisk and run towards the safe-haven currency, the United States dollar.

This caused a massive selloff in the cryptocurrency space as Bitcoin traded below $30,000, a price point not traded since May 2021, when the market crashed by a little over 50%. As a result of the selloff and also as a result of how the UST programmable stablecoin works, it caused a massive decline in LUNA, the depegging of the stablecoin, UST and also the over 70% decline in Anchor Protocol’s native token, ANC.

How the UST mechanism works

LUNA serves as a collateral asset to maintain UST’s dollar peg, according to Terra’s elastic monetary policy. Therefore, when the value of UST is above $1.00, the Terra protocol incentivizes users to burn LUNA and mint UST. Conversely, when UST’s price drops below $1.00, the protocol rewards users for burning UST and minting LUNA.

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This means, that during UST supply reduction, LUNA’s valuation should decrease. Similarly, when UST’s supply expands, LUNA’s valuation increases, noted Will Comyns, a researcher at Messari. On May 8, UST’s market underwent contraction for the first time in two months, dropping by 28.1 million below zero. Simultaneously, LUNA’s supply expanded by over 436.75 million above zero.

The contraction and expansion seen on the day was a result of market participants who mass sold UST worth almost $300 million. This further continued as Bitcoin fell below $30,000 which caused the LFG foundation to initially deploy $1.5 billion to be loaned out to professional market makers to defend the UST peg. However, according to CoinDesk the foundation is scrambling to line up fresh capital to back the project.

What is happening now?

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