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Here’s what happened to LUNA and why the price may continue to plummet

                                                            Terra Protocol und sein Ökosystem sind seit einigen Tagen an der Spitze des Cryptowährungsmarktes, und das nicht ohne Grund.  UST – die algorithmische Stablecoin des Protokolls – verlor seine Bindung und fiel auf etwa 0,30 $.  Unterdessen stürzte LUNA – die andere Cryptowährung im Ökosystem – in wenigen Tagen um über 90 % ab und erreichte einen Tiefststand von etwa 4 $ (auf Binance).

This article tries to explain what happened to both cryptocurrencies and why it might be difficult to get out of this situation. To do this, it is important to understand how the algorithm that is designed to maintain UST’s 1:1 dollar peg works.

How does the UST Algorithmic stablecoin work?

As explained above, the protocol consists of two main tokens: Terra (UST) and Luna (LUNA).

Users can imprint UST by burning Luna in the Terra Station portal. The protocol’s official documents provide some examples that make it relatively easy to understand how dynamics can work in theory.

Think of the entire Terra economy as two pools: one for Terra and one for Luna. To maintain Terra’s price, the Luna supply pool increases or decreases Terra’s supply. Users burn Luna to imprint Terra and Terra to imprint Luna, all prompted by the protocol’s algorithm market module.

It’s worth noting that this is conceptually different than regular stablecoins like USDT or USDC backed by fiat or fiat equivalents.

To make it easier to understand, imagine that the price of UST is currently $1.01. Users can then use the Terra Station’s swap feature and exchange $1 worth of LUNA for 1 UST. The market would burn 1 USD from Luna and mint 1 UST. Users can then sell their 1 UST for $1.01 – gaining $0.01 in the process.

Now imagine the opposite – UST is trading at $0.99. Users can do the opposite – exchange 1 UST for 1 USD from Luna. The swap burns 1 UST and mints 1 USD from Luna – users benefit 0.01 UST from the swap.

The bigger the difference to the peg, the more profitable it would be arbitrage. Theoretically, if the bond is lost and the price of UST falls below $1, users can burn UST for LUNA and sell it for a bigger profit.

However, this also means that the market capitalization of UST should be lower than that of LUNA, since the opposite would mean that a hypothetical Terra Bank run (read: redeeming UST against LUNA) would prohibit some users from redeeming $1 of UST for $1 of Luna.

In the last few days, all of the above hypotheses have become a reality.

UST peg disappears, LUNA price crashes over 90%

In the past few days, certain events have unfolded that have caused a cascade of problems for the Terra ecosystem. Here’s what the UST chart (reminder – it’s supposed to be a stablecoin pegged 1:1 to USD) looks like (on Binance):
Here’s what happened to LUNA and why the price may continue to plummet, Crypto Trading News TradingView
UST price fell to a whopping 0.225 USDT on May 11, meaning what was meant to be a stablecoin lost nearly 80% of its value in a matter of days.

This is what the LUNA diagram looks like at the same time:
Here’s what happened to LUNA and why the price may continue to plummet, Crypto Trading News TradingView
The price crashed to around $4 (on Binance) on May 11, down around 90% over the past few days.

Speculation as to why this happened is rife, and Do Kwon – CEO of Terra – has yet to find a formal explanation.

However, on May 9, in a lengthy thread, he explained that the Luna Foundation’s Guard Council had voted to raise $1.5 billion in capital — in BTC and in UST – use to defend the bond.

1/ The LFG Council just voted to deploy 1.5Bn capital (0.75Bn in BTC, 0.75Bn in UST) to allay market concerns about UST. A little more context on the why and how:

— Do Kwon 🌕 (@stablekwon) May 9, 2022

Two days later and with much more volatility than perhaps anticipated, UST is trading at 50% of its peg value while LUNA continues to plummet.

The problem is that as long as UST’s price is below its rate, it creates an arbitrage opportunity for users to burn UST and mint LUNA. Do Kwon already mentioned that they are working on a recovery plan, but at the time of writing there is nothing official yet.

Just before announcing a recovery plan for $UST. Keep doing.

— Do Kwon 🌕 (@stablekwon) May 10, 2022

Essentially, this arbitrage opportunity will not cease to exist until the UST value is reset back to its $1 peg, creating a loop where LUNA is always available at a discount through the Terra Station.

Source: Crypto News Deutsch

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