TerraUSD (UST) is an algorithmic stablecoin, which was recently the fourth-largest stablecoin by market value. UST is on the verge of collapse due to its repeated failure to maintain the $1 peg. A peg is a one-to-one link to the underlying assets, where the price of 1 UST should be equal to $1. Terraform Labs, the founder and developer of Terra, halted block production on Thursday “to prevent governance attacks following severe $LUNA inflation and significantly lower attack costs,” as stated on Twitter. Due to the cheap price of LUNA, it is possible for bad actors to acquire enough LUNA cheaply to attack the network by forcing a majority vote. Terra is a Proof-of-Stake network where possession of coins directly grants power and voting rights to make decisions and propose changes to the network.
How does UST work and what has happened?
Terra’s UST aimed to become a stablecoin whose minting and burning process was programmatically executed by a computer program—an algorithmic process. Terra “promises” that people can exchange 1 UST for $1 worth of LUNA at any time (whose value fluctuates according to supply and demand). If UST breaks its upper peg, arbitrageurs can exchange $1 worth of LUNA for 1 UST, profiting from the premium. If it breaks its lower peg, traders can exchange 1 UST for $1 worth of LUNA, thereby also making a profit on this transaction.
This mechanism failed during a period of enormous stress on the network. When UST lost its one-to-one peg, it led to a modern “bank run,” as traders tried to exchange their UST for LUNA. The demand for LUNA exceeded what Terra could handle, causing network fees to rise to 40% of a transaction. This, in turn, led to further declines and resulted in a so-called “death spiral” for the Luna token. Binance, one of the largest centralized exchanges, has delisted LUNA and UST, making them no longer tradable on this exchange. Whether there is a future for LUNA and UST remains uncertain. These situations highlight once again how important it is to conduct your own research and remember that there are always risks involved. In such times, it is important for the crypto community to look out for one another. People have lost thousands of euros during this crash. Support each other and especially remember that money is not the most important thing!
– The Knaken Team –
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