In less than 48 hours, the USD stablecoin TerraUSD (UST) has lost its dollar peg for the second time. The market price for TerraUSD fell to as low as $0.65 on Monday, losing $0.35. The price of LUNA, its sister token, has fallen by 44% in the past 24 hours, ending at $35.
The UST, a so-called algorithmic stablecoin, works with LUNA to keep the price at $1 using a set of on-chain mint and burn procedures. In theory, these mechanics ensure that traders may always exchange $1 worth of UST for $1 worth of LUNA, which has a floating price and is supposed to serve as a kind of shock absorber for TerraUSD price.
LUNA price declination threatens the system of UST’s stabilizing mechanism
The price decline of LUNA puts its market value below that of TerraUSD, threatening the entire system of UST’s stabilizing mechanism because it indicates a Terra bank run may result in some users being unable to exchange $1 worth of USD for $1 worth of LUNA.
The $1 price peg was broken this weekend, with the token plummeting to $0.985 on Saturday. Sunday’s recovery wasn’t Terra’s first or largest “depeg,” but it was the first time the algorithmic stablecoin fell below $1 since starting a much-publicized campaign to expand bitcoin and avalanche reserves.
The price decline comes from heavy selling pressure on the token, likely from traders who were spooked by the news that LUNA’s market cap had fallen below TerraUSD’S.
After the Luna Foundation Guard (LFG) revealed on Sunday that $1.5 billion of its massive bitcoin reserves would be “loaned” out to professional market makers to proactively defend the TerraUSD dollar peg, today’s depeg followed suit.
Monday’s activities, according to Jose Maria Maceda of Delphi Digital and an LFG council member who helps manage the group’s reserves, were the most demanding stress test the system has ever encountered. But he added that the TerraUSD-LUNA market capitalization flip is not a cause for worry because of LFG’s reserves.
The Terra appeared to drain all of the funds (around $1.3 billion) from its confirmed bitcoin address.
Do Kwon, the outspoken CEO of Terra’s builders, Terraform Labs, tweeted a few minutes later: “Deploying more money – steady lads.”
According to market makers, bitcoin reserves are being used to defend the UST dollar peg on platforms like Curve, enabling users to trade between UST and other currencies such as the dollar-pegged USDC and Tether stablecoins.
There are currently no means for customers to claim UST or Luna for bitcoin directly. Still, there are plans to integrate Terra’s bitcoin reserves into the smart contracts, and there is no direct link between the LFG reserves and Terra’s on-chain mint and burn mechanism.