We are seeing all over the news that UST broke its peg and along with that Terra (LUNA) shaving off half its value overnight. At the time of writing, Luna is still down by almost 47% spurring a sell-off for many other coins including Bitcoin and Ethereum.
What exactly is UST and what’s the big deal about it “breaking” its peg? Heck what on Earth is peg anyway? In this article, I’ll be covering this whole saga as best as I can with NO technical jargons or overcomplicated phrases. Some details may be lost as I attempt to break down some very complicated ideas but do understand that the objective of this article is to give the average reader a borderline understanding of what’s happening.
What on earth is a PEG?
In the crypto world, when we say that “UST is pegged to the dollar”, in its most basic understanding it means that 1 UST should always be worth $1. Therefore when headlines go “UST loses its peg”, it means that 1 UST coin has fallen below $1.
What is the big deal about UST falling below $1?
Here is where it gets complicated. UST is a stablecoin which by definition is as follows,
A stablecoin is a class of cryptocurrencies that attempt to offer price stability and are backed by a reserve asset
Investopedia
Stablecoins are crucial in crypto markets as in most cases, such coins are backed by either the US dollar (Eg: USDT) or backed by other cryptocurrencies (Eg: DAI). As such, in times of volatility, such coins are seen as safe havens as their value would hardly fluctuate.
If I could expand on this a little more, most of us here would be familiar with Tether and to date, it continues to be the world’s most popular stable coin simply because every 1 Tethercoin that you hold is equivalent to the 1 US dollar. It is physically backed by a legitimate $1 USD note.
Vaguely, it would also mean that more USDT coins cannot be introduced on the network without Tether Limited having more US dollars to be pegged to the coin. Note that this is the narrative that by and large everyone believes, (myself included) however note that “there is no guarantee provided by Tether Ltd. for any right of redemption or exchange of Tethers for real money – that is, Tethers cannot be exchanged for U.S. dollars.”
So this begs the question if UST is a stablecoin, how is it possible that it ever falls below $1?
This is where things get interesting because UST falls into a category of stablecoins known as algorithmic-backed stablecoins. This may sound daunting but the best example that I can give to illustrate this point is how such stablecoins often have automatic mechanisms (at higher levels known as smart contracts) to maintain their price stability.
It is very similar to that of a central bank which manipulates a fiat currency’s price by controlling the supply of cash.
In this case, we need to take it at face value that at its most simplest form of understanding, the price stability of UST is determined based on the demand and supply of the LUNA token. If we accept the above to be the basis of this whole scenario, it would mean that when the price of UST rises t0o high, automatic mechanisms would “make” more LUNA tokens. Based on the laws of demand and supply, if we introduce more supply into an ecosystem where demand is constant, prices would fall and with such automatic mechanisms in place, maintain equilibrium.
Likewise, when the price of UST lowers, automatic mechanisms would “destroy” LUNA tokens. The above being true, with less LUNA tokens in supply, prices would rise and once again with such automatic mechanisms in place, maintain equilibrium.
Now there is a lot more that goes on behind the relationship between UST and LUNA but once again I am trying to cramp tons of overlapping White papers into a single article. (You can read about the risks of stablecoins here)
So why did UST break its peg?
Over the weekend there were some big transactions within UST. It is difficult to get a timestamp on the transactions but here are some key events:
- $150m of UST was removed from liquidity by Terraform Labs. (According to them, to be redeployed into another liquidity pool next week)
- 1 minute later, another wallet dumped $84m of UST.
- Along the way “hundreds of millions worth were sold in mere moments, along with over $2 billion in withdrawals from Anchor Protocol, essentially a bank for UST”
This caused UST to break its peg and drop to below $1.
With this, the floodgates opened, and with more and more selling, ultimately the “automatic mechanisms” holding the UST stablecoin together failed causing the UST to reach a low of $0.70 at one point in time.
Did UST cause yesterday’s crypto sell-off?
The short answer would definitely be yes. UST is meant to be a stablecoin that investors flock to for safety amidst volatile times. It wasn’t some small side project in fact it was the 4th largest stablecoin by market cap. Therefore with the UST decoupling + macroeconomic concerns well … the result is what you see today.
Our cryptocurrency investing trainer, Aik Keong shares his view on how this could impact the larger crypto ecosystem.
Will UST be pegged to $1 again?
At the moment, the Luna Foundation Guard (LFG) is buying back UST in an effort to bring prices back up. This means that investors are selling out of UST and that a 3rd party needs to step in. This is important to note as at present, UST is being backed by its “automatic mechanisms” as well as additional capital from LFG.
There are a lot of rumors going on that so long as capital from LFG remains, UST will eventually reach $1 but the question remains as to what if the capital runs out? Part of this capital is also in bitcoin so what if the inflation report tomorrow turns out worst than expected and bitcoin falls even further?
Only time will tell but for now, I’ve paper-handed all my LUNA as indeed the narrative is different and the fundamentals of this project are indeed very different from when it first started.
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