If you haven’t heard, in the past few days, the stablecoin UST had depegged and is undergoing a death spiral. In the chaos, it had brought down the price of LUNA from ~$87 to $0.26 at the point of writing and dragged down the entire crypto markets.
Although the current bear market isn’t entirely due to the death spiral of UST (inflation has a hand in it too), it certainly had an impact on the crypto markets.
Here, we explore how (and why) the UST crash will impact the rest of the crypto ecosystem.
What’s UST?
UST is an algorithmic stablecoin that isn’t backed by any collateral. Instead, its value is managed by an algorithm that uses an arbitrage mechanism to incentivise the market the keep UST’s price pegged to the US dollar.
When the price of UST goes above $1, traders can convert $1 of LUNA into UST profiting from the difference. And vis versa, when the price of UST goes below $1, traders can convert their UST into LUNA for the difference. (you can read about Terra LUNA here)
This works well in normal markets.
But what happened recently wasn’t ‘normal’.
The Death Spiral
In the event where everyone wants to ‘cash out’ their UST, we end up with a bank run where everyone wants to withdraw their money, but the ‘bank’ doesn’t have enough assets to fulfil all the requests.
Couple that with the rush to sell off existing LUNA by hodlers who just want to get out of the entire ecosystem, a crash was inevitable.
Between 7 – 9 May 2022, there were whales selling a significant amount of UST which caused its price to drop and depeg from the US dollar. For details, read Bryan’s break down of the series of events following the initial depeg that lead us to the crash of UST and LUNA.
The death spiral was a known risk of the UST stablecoin. And most investors should have gotten in knowing that there’s a chance that UST and LUNA could go to zero.
So what?
If you’re not in crypto, UST may sound like it’s just dust in the wind. However, just before the crash, UST’s market cap was a whooping $18.71B.
Anchor, a lending and borrowing defi application offered a tantalising 19% annual yield on UST deposits.
While things were rosy, many funds and investors had parked their money there for the high yield. In fact, just before the crash, there was ~$14B of UST deposited into Anchor. For context, the Secretlab’s co-founder’s GCB cost S$36m. With $14B, you can buy ~400 GCBs! (not including the conversion rate).
What now?
How would the UST-LUNA meltdown cascade to the entire crypto ecosystem?
1) Drop in confidence of stablecoins as a whole
Although unlike UST, USDC and Tether are collaterised stablecoins backed by actual dollars, most people do not separate them as a different class of asset.
The mass adoption of UST by unknowing investors who were in only for the yield could bring down the confidence of stablecoins in the near term and this would likely slow down the adoption of cryptocurrency in the broader context.
2) Downward pressure on other cryptocurrencies
In Mar 2022, the Luna Foundation Guard (LFG) starting filling up its reserve with other cryptocurrencies with an initial purchase of ~25k bitcoin for $1.1M on 26 Mar 2022. As of 6 May, they had:
- BTC 42.53K (1.53B USD)
- LUNA 1.69M (135.52M USD)
- USDC 23.56M (23.55M USD)
- USDT 26.28M (26.28M USD)
- AVAX 1.97M (111.7M USD)
These cryptocurrencies were accumulated as backups to defend the UST peg should anything happen.
Unfortunately, the depeg and death spiral happened almost immediately and LFG was forced to sell their reserve cryptocurrencies in order to buyback UST in an attempt to bring its price back up.
To add fuel to the fire, there were many funds that had positions in UST and LUNA. These funds may be forced to sell off portions of their remaining cryptocurrencies if their investors choose to liquidate their positions.
All these selling in an already downward market dampened by inflation and the Fed’s ongoing actions results in a double whammy that maintains a strong downward pressure on the overall market.
3) Potential tightening of Regulations
As a DeFi project that targeted retail investors and marketed by many VCs and funds, many regulators are not doubt paying attention to the current fiasco.
US Treasury Secretary Janet Yellen mentioned UST during a hearing on 10May and conveniently lumped its crash with the entire cryptocurrency markets:
We might see regulators coming in to clamp down on the cryptocurrency markets as an aftermath of the UST-LUNA crash.
What should you do now?
At the point of writing, UST has not restored its peg and is trading at $0.38 while LUNA has crashed from $87 to $ 0.004.
If you’re stuck with LUNA or UST, there really isn’t much you can do now.
However, LFG is reportedly looking to raise over $1B to rescue UST and Do Kwon (founder and face of the project) has announced that the Terra team is looking for ways to “weather the crisis”:
Getting into LUNA now is like buying a lottery ticket. You must be prepared to lose the amount invested as one of the possible outcomes of LUNA is the abandonment of the project. When that happens, the fans of LUNA are called “LUNAtics,” will really become lunatics.
It could be one of the all-time biggest rug pulls in crypto’s history.
Are we heading into a crypto ‘winter’?
With the entire world economy in turmoil with rate hikes, rising fuel prices and massive inflation looming, all investment markets are not looking well. It’s like a perfect storm of events and crypto is definitely not a safe haven investment as some have touted it to be. It never was…
If we were to refer to cryptocurrency’s past performance, there’s a possibility that we are looking at the start of the crypto winter. Comparing the crypto markets in 2017/2018 and today, there are many similarities, although they are played out in different segments of the crypto market.
One major difference here is that there are more people invested into crypto in this cycle, and many of them might not be trained or are well-informed to understand the risks involved in crypto investing. We have listed companies, institutional investors and banks getting involved into crypto today. Retail investors are the lowest rung in the crypto market, therefore it’s highly recommended to have a strategy to stay level-headed and not let your emotions take over your investments.
If anyone is considering to start investing into cryptocurrencies, now is a great time to learn from a mentor and get into a good quality community. This way you can navigate the crypto space safely and have the support of a community to avoid the traps and pitfalls out there. As for those that have invested, you got to have a strategy to enter and exit the market as well as have a profit taking strategy such that you can weather through the storms of crypto investing.
