LUNA: Why it crashed and how it roughly happened?
Hey all, long time no post. Almost half a year actually. I was busy with career switch, had to learn a crazy amount of new stuff (tired mentally haha). Hardly had the time for blogging about crypto or even follow up on latest stuff. But all that hard work had paid off and I'm now doing tech work full time!
Me at work
Anyway, LUNA (Terra) blew up really bad. My definition of bad used to like -90% which is expected for altcoins but LUNA here has redefined it for me.
Well I'm kinda back from my hiatus cause of the articles I saw floating around talking about how $LUNA crashed (some used it to promote their paid stuff wtf) but none actually explained simple enough for anyone to understand. Since I'm technically a (smol) crypto blogger, I feel compelled/triggered enough to try piecing everything together in a digestible manner so retail would know their money's cause of death and HOPEFULLY not repeat with the next LUNA fork.
What is LUNA and UST?
LUNA is the native token of Terra protocol with an elastic token supply. UST is the stablecoin that can be minted 1:1 ratio by depositing LUNA at Terra station.
At all times, 1 LUNA = 1 UST.
How LUNA and UST work?
Imagine that 1 LUNA = $10 and 1 UST = $1 at its supposed peg.
Minting UST
I can take 1 LUNA to this place called Terra Station and exchange for 10 UST
The 1 LUNA exchanged, will be taken off the total token supply
LUNA supply ↓ whereas UST supply ↑
Price of LUNA ↑ while UST ↓
Redeeming UST
Likewise, with 10 UST, I can go to Terra Station and exchange for 1 LUNA
10 UST is burned
LUNA supply ↑ whereas UST supply ↓
Price of 1 LUNA ↓ , UST ↑
Either actions create arbitrage opportunities, incentivizing traders to bring UST back to $1 peg. Let's go over what should happen when UST depegs...
If UST goes > $1.01 (expansion)
$1 LUNA can be swapped for $1.01 UST
Earning a profit of $0.01 or more in UST
UST supply ↑ = UST price ↓
LUNA supply ↓ = LUNA price ↑
Arbitrageurs can choose to realize the profit by selling UST
If UST goes < $0.99 (contraction)
$0.99 UST can be swapped for $1 LUNA
Earning a profit of $0.01 minimally in LUNA
UST supply ↓ = UST price ↑
LUNA supply ↑ = LUNA price ↓
Arbitrageurs can choose to realize the profit by selling LUNA
Take note of the underlined portion.
Based on the above explanation on the mechanism, it should work pretty well if no one sells anything. Hmmm, doesn't it sound awfully familiar?
Why did UST depeg?
The million dollar question that many articles fail to address.
It all boils down to the arbitrage mechanism, it obviously doesn't work in times of fear where people are selling both UST and Luna! There is nothing that alleviates sell pressure.
So this was roughly what happened
More UST supply than demand so UST goes below $1
UST is swapped for LUNA, reducing UST supply
More LUNA minted = LUNA price goes down fueling the selling
However, UST selling continues so it is still below peg
Even more UST swapped for LUNA
Even more LUNA is minted so LUNA price goes down further
Everything went to hell from then onwards
This is the death spiral that so many had warned about yet few heeded. Token design was broken from the beginning.
Not forgetting Anchor Protocol's 20% APY on UST, increase UST listings and a cocky founder. They all have a part to play in this mess.
But isn't it a "stable" coin?
Yes but stable doesn't mean people can't go retarded and sell for $0.50. It isn't "forever1dollarcoin" you know.
Closing thoughts
I don't have any exposure to LUNA/UST, only traded it a few times. It is hard to imagine how it exactly feels.
But what happened has happened, a loss is a loss but with dedication and persistence one can make a stronger comeback! Just like many others on CT who lost it all because of leverage and came back making even more money than they originally had so it is possible!
For anyone affected who has a hard time coping with the loss, please seek professional help or talk to someone.
Till then, stay safe and survive.
Disclaimer: I am not endorsed by any of the platforms mentioned here. It is strictly my personal opinion and should not be regarded as investment advice. Please do your own due diligence.
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