What went wrong with Luna?


Cryptocurrencies have been in a lean spell for a bit of time, with values reaching new lows. One particular coin has plummeted severely. LUNA has lost 98% of its value in the last few days, and fear has crept into the minds of investors and coin holders. It has degenerated to the extent that they have pinned suicide hotlines to the community’s reddit page. How did it come to this? 

What is LUNA and what is UST. The connection between them 

To fully understand all there is to know, there are a number of things to be aware of. Terra is a cryptocurrency based in South Korea that was founded in January 2018 by Do Kwon and Daniel Shin. Terra distinguishes itself by the use of fiat-pegged stablecoins.

A stable coin is ideally a cryptocurrency that behaves similarly to a real-world asset class or currency. This means that it is usually the equivalent of that currency which it is “pegged to”. Typically, you’ll find that different stable coins are pegged to the dollar itself, like USDT, USC (and the affected UST), and these provide an avenue to save in USD but on the blockchain level, so users can have access to making transactions or just buying and selling other crypto assets ‌easily. 

Another purpose of a “stable coin” and part of its general idea is for times of devaluation, either on the blockchain or in real life, like when the local currency of a place is losing value or purchasing power, users can easily save value on the blockchain with stables, and even when other crypto currencies are losing value, like ETH and BTC. In an ideal world, a stable coin does not get devalued and maintains its “peg” (or fix or 1:1 ratio) with the local currency it represents.

Going back to the Terra Blockchain, it combines the benefits of cryptocurrencies and pairs that with the stability that comes from fiat currencies. We can view it as a cryptocurrency with two halves, which are Terra, the stablecoin, and LUNA, the cryptocoin. The blockchain works to keep its one-to-one peg using an algorithm that automatically regulates the supply of the stablecoin based on its demand. 

What is UST?

In the actual sense of things, Terra in itself is not a stablecoin; it is pegged to the UST. UST is a stable coin that is tied to the dollar, and hence, all things being equal, Terra was supposed to be secure.

The issue here is that UST is not a standard stablecoin like the others; it is what is called an algorithmic stablecoin, which means that it has no physical reserves and instead relies on smart contracts to keep the value at $1 or as close as possible to it. However, the crisis at hand has seen a depegging of the UST, with the former stablecoin now trading as low as $0.30. With the price falling so low, investors and holders have rushed to liquidate their holdings and positions in both LUNA and Terra quicker than the algorithm could handle, which caused the fixed price of the stablecoin to fail, and at this moment, both sides (LUNA and Terra) are almost useless in value. 

Current Situation 

The relationship between LUNA and UST is such that with LUNA’s current price at $0.10, swapping 1 UST gives 10 LUNA. Swapping 10,000 UST would lead to the minting of 100,000 LUNA. This is a powerful cause for concern, because as holders redeem their UST for LUNA, the supply of LUNA increases, which drives the price even further down, and as more people redeem, the price goes down even more. The supply of LUNA in the market has increased over 20 times in the last 4 days, going from 346 million all the way to 7.1 billion. In summary, this huge supply increase facilitates prices going even lower.

In November 2021, a thread went live on Twitter with a user detailing how an attacker could break the Terra Blockchain and make a profit doing it, and that attack seems to be what is unfolding right before our eyes.

For further reading on speculation of the attacker’s actions, another twitter thread was done.

On May 10th, Don Kwon, the founder of LUNA, tweeted, “Close to announcing a recovery plan for $UST. Hang tight”. On May 11th, he further addressed the LUNA community in a thread that can be read here,

ending it by saying: ” Terra’s return to form will be a sight to behold.” We’re here to stay. And we’re going to keep making noise.🌕” We look forward to seeing how this unfolds. 

Ayo Yissa

Ayo Yissa

Technical Writer. Interested in blockchain and machine learning

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