UST Depegged: Terra’s Biggest Test

Latest Update

Update as at 13 May 2022, 09:00 UTC+8

• Price of UST bounced around $0.40 last night, before plunging straight down to $0.20 in the last hour or so. There is still 11.3B supply of UST yet to be redeemed. 

• The earlier governance proposal at Mars Protocol to allow users to withdraw their UST from lockdrop looks set to pass with quorum reached and overwhelming support.

• LUNC (formerly 'LUNA') has now fallen by another decimal place to below $0.001. Circulating supply has ballooned to 923B.

• Total TVL on Terra is down to $1.53B. Anchor TVL is now at $1.05B.

• Overall crypto market has stayed largely flat through out the night, with BTC still trading at $29,000 levels, and ETH at ~$2,000.

On 12 May 2022 15:36 UTC+8, TerraForm Labs issued a statement on Twitter, regarding a number of measures being undertaken:

• Primary goal is to expel bad debt by passing Prop 1164. This will expand the base pool size and accelerate burn of UST.

• Three emergency actions are being executed by TFL as well. This includes a proposal to burn the remaining UST in the community pool, TFL will burn the remaining UST cross-chain on Ethereum, and staking 240 million LUNA in order to defend the network from governance attacks.

• If all three actions are executed, over $1.3B in UST will be burned or ~11% of outstanding supply. 

On 11 May 2022 19:00 UTC+8, Do Kwon, the founder of Terra published a tweet thread addressing the current depegging situation: 

• The path forward will be to absorb all UST which wants to exit, before the repegging can occur. 

• Increase the BasePool from 50 million to 100 million SDR and decrease the PoolRecoveryBlock from 36 to 18 blocks

• This will allow minting to increase from $293 million to $1.2 billion, thus increase the burning of UST

• Do Kwon believes the supply overhang should continue to decrease until parity is reached.

• The mechanism of UST will be adjusted to become a collateralized one after this.

The Terra ecosystem is currently experiencing a crisis, with UST having depegged 3 times over the last 3 days. As this is a developing story, we will continue to update this article with further information. Here’s how things unfolded:

May 1st Week

It started with Anchor implementing its highly anticipated semi-dynamic earn rate on May 1st. When it was first introduced, markets were relatively quiet, with prices on major assets moving sideways. 
With the new update, Anchor earn rates are adjusted each month by up to 1.5% in either direction depending on the yield reserve. For example, if the yield reserve increases by 3%, the earn rate will increase by 1.5%. The same goes for a decrease in yield reserve, where the earn rate will drop by 1.5%. For the month of May, the earn rate has dropped from 19.5% to 18% due to a decrease in yield reserves. However, Anchor has capped the APY to a floor of 15% and a ceiling of 20%.

Instead of seeing a slew of withdrawals as anticipated, the total value locked (TVL) in Anchor slowly increased, hitting a high of $17.15 billion on May 5th. This all-time high coincided with the FOMC announcement regarding rate hikes. In anticipation of this, many crypto investors held stablecoins in their portfolio, UST included. However, soon after the Federal Reserve announcement, TVL in Anchor began to fall gradually, while major assets experienced a relief bounce.

May 7th / 8th Weekend

However, the FOMC announcement relief bounce quickly shifted into a full-scale dip on May 5th, and BTC and the wider crypto market, including LUNA, were not spared. Anchor started to experience UST outflows, which only worsened over the weekend. Throughout the weekend, over $3B was withdrawn from Anchor resulting in a decrease of 22% in Total Value Locked (TVL) from its all-time high. 

There were a number of large redemptions from Anchor, with these wallets bridging their UST back to Ethereum before selling them to other stables. This sparked fear amongst other smaller investors, with many following suit withdrawing from Anchor and selling their UST to other stables. Such heavy sell pressure ultimately placed a lot of pressure on the UST peg, and it finally broke causing it to momentarily fall to $0.98. This account in particular withdrew over $100 million from Anchor, before proceeding to send the funds to Binance as well as bridging through Wormhole. Shortly after, a swap of $85M UST to USDC was conducted on Curve.

Over the course of the weekend, the UST curve pool suffered severe imbalance twice due to massive sell pressure from UST to other stablecoins. On-chain analysis showed that the peg was breached but also swiftly defended by whales. Terraform Labs (TFL) was also forced to remove $100M in UST liquidity from the pool in order to balance the pools out, which was confirmed by Terra founder, Do Kwon. However, selling pressure on UST did not abate.

At the same time, LUNA’s price fell by 25% when the UST peg broke. LUNA is meant to act as a stabilizing mechanism to UST. For example, if UST is trading at $0.98, arbitrageurs can buy it and redeem it for $1 of LUNA. Therefore, the price of UST is brought back to peg by arbitrageurs buying it up. Over the weekend, with UST below peg, UST was purchased and redeemed for LUNA, which was then dumped on the open market. Hence, huge selling pressure caused LUNA to freefall, exacerbated by overall bearish sentiment in the wider crypto market.

May 9th to Now

UST Depegs Yet Again

UST Price Chart (last 24 hours) Source: CoinGecko

While the events over the weekend may have spooked some investors, May 9th -10th was when things turned really ugly as UST holders continued selling. The drop in the price of LUNA also caused cascade liquidations on Anchor. Under significant stress, UST depegged for the third time in 3 days, falling to a low of ~$0.60.

LUNA Price since 4 May Source: CoinGecko

With UST falling so much off its $1 peg, as mentioned above, this in turn created immense sell pressure for LUNA, causing it to plummet to a low of ~$23 on May 10th. 

Source: DeFiLlama

Withdrawals accelerated rapidly still since Monday, falling by another ~$11B. ~80% of the drop in TVL in the past <48 hours are from Anchor (~55%) and Lido (~25%) alone. The total TVL for Terra ecosystem now stands at $9.6B, which is a 55% drop from the peak of $21.7B on 5th May.

Source: Dune Analytics, @kenchan0824 / Wormhole Daily Outbound UST

The Wormhole Bridge correspondingly saw a spike in outbound UST, as >1B UST was bridged out of Terra on 8th May alone. 

Efforts to Defend the Peg

Due credit to the Luna Foundation Guard (LFG), the council acted fast to make available $1.5B in funds (half in BTC and half in UST) on May 9th to OTC trading firms in preparation to defend the peg if needed. The funds were mobilized pretty quickly, and were deployed to various derivatives exchanges, e.g. Binance and OKX. At the same time, onchain operations to defend the peg also began. 

However just 2 hours after the initial LFG announcement, Do Kwon tweeted again saying that more capital were being deployed, and shortly thereafter, all remaining BTC in the LFG reserve were also transferred to exchanges. The LFG reserve, which at peak on 3rd May had close to $4B in balance, has now slightly less than $200M left (post-deployment of funds to defend the peg).

The deployment of funds seemed to have, for now at least, stopped the death-spiral of UST, with the price having bottomed out at $0.61 at 8.30AM (UTC+8). Since then, the price of UST has crept cautiously up to ~$0.90. As most of the action has happened on centralized exchanges (and possibly OTC), we have not been able to ascertain to what extent the LFG reserve funds have been deployed to defend the peg, and how much of the deployed funds are left. We expect more details to emerge in the coming hours / days.  

Source: Binance, via Cryptowatch, snapshot as at May 10, 2022 6:00pm (UTC+8)

Nonetheless, orderbooks for UST on exchanges remain thin. All eyes on derivatives exchanges now to see if confidence returns to the market. On Binance, a formidable wall around $1 is forming, with $130M+ in USDT and BUSD sell orders.

Other bits and bobs

There is a rumor spreading about Jump, Alameda, etc. providing another $2B to “bail out” UST. Whether this rumor is true or not, it makes perfect sense for them to spread. The biggest question here is, even if they can get it to $1 by some miracle, the trust is irreversibly gone

— Larry Cermak (@lawmaster) May 10, 2022

There is currently a rumor circulating that TFL / LFG is attempting to raise more funds from institutional investors to “bail out” UST. The structure of the deal and its longer-term implications for the project are unknown, but right now any funds that can go towards defending the UST peg will be much welcome. The big question now is - how much will be enough? 

Source: Dune Analytics, @lewi / Stablecoin Liquidity

The UST Curve Pool, which is the main source of onchain liquidity for UST, has significantly gone out of balance since all the volatility started, with UST dominance of the pool now at ~95%. At time of writing there is only $20M worth of UST liquidity left in the pool. For the peg to hold eventually LFG will need to get to rebalancing the pool at some point, either through injecting more 3CRV, or withdrawing some UST (possibly a combination of both). 

Source: CoinGecko

Price volatility of LUNA have cause what was once unthinkable to happen - that the LUNA market cap is now below that of UST. From this analysis, such an event could ultimately lead to a vicious burn / mint cycle of UST / LUNA. How TFL / LFG intends to break this vicious cycle when the peg is restored remains to be seen. 

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This article was produced in collaboration with Wendy and Zhong. You can follow both of them on Twitter here and here.