What happened to Terra?
The news about Terra USD and LUNA was shocking. How and why did it happen? Let’s figure out the reasons and weigh the potential consequences for the industry.
The collapse of the UST algorithmic stablecoin and the highly capitalized LUNA token was a real shock to the crypto industry, devaluing many users’ savings and multimillion-dollar assets of large corporations in a matter of days.
Shortly before the collapse, the Terra ecosystem, which includes MakerDAO, Uniswap, Compound, and other veterans of decentralized finance, could compete with Ethereum in TVL. The Anchor platform ranked third overall in the DeFi Llama rating.
Many developers were inspired to create similar projects and reserve crypto funds by the rapid growth of Terra USD (UST) and the popularity of algorithmic stablecoins
However, everything changed within a few days: UST suddenly lost its peg to the dollar, and the associated LUNA token almost devalued.
- The collapse of LUNA and UST has shaken the confidence of the crypto community in the prospects of algorithmic stablecoins.
- The news about the Terra ecosystem attracted the attention of regulators and mainstream media.
- The collapse of LUNA and UST had a negative impact on the rest of the market, creating serious problems for a number of DeFi projects.
Step by step
Throughout the time there were still skeptics who doubted the infallibility of the Terra mechanisms. For example, at the end of 2021, the user Freddie Raynolds warned the community in a series of tweets about the vulnerability of the project to well-coordinated attacks using significant capital.
In early May, just before the Terra collapse, the interest rate on Anchor deposits was reduced to just under 18%. The decision was made to smooth out the growing imbalances and solve a number of issues, including the depletion of project reserves.
In response, the users massively started to withdraw assets from the protocol. On May 7, the volume of Anchor deposits exceeded 14 billion UST. A day later, it was already 11.77 billion UST (-16%).
At the same time, the Curve Finance team reported that someone began selling UST in large quantities, causing the stablecoin to lose its peg to the US dollar (the asset was trading around $0.98 on May 8). The developers stated that these actions ‘faced a lot of resistance’ in the form of ETH and stETH counter sales.
Mudit Gupta, the head of the security department of the Polygon project, noted that the UST incident was accompanied by some suspicious operations.
According to him, Terraform Labs removed 150 million UST of liquidity from Curve on May 7, following which an unknown newly created address transferred over 84 million UST to the Ethereum network. According to Gupta, ETH was dropped a few minutes later, causing a sell-off.
Shortly afterwards, the company withdrew an additional 100 million UST from Curve.
When the stablecoin rate began to fall, an unknown market participant began selling ETH and buying UST. He was trading below the binding level, allowing him to profit..
Do Kwon, the founder of Terraform Labs, explained that the company withdrew 150 million UST from Curve in order to prepare for the 4pool launch. Following that, it withdrew another 100 million UST ostensibly to “reduce the imbalance.”
Kwon also claimed Terraform Labs had nothing to do with the 84 million UST operation. He also stated that the company has no plans to decouple the stablecoin from the US dollar.
The non-profit organization Luna Foundation Guard (LFG) provided loans for OTC firms totaling $750 million in BTC and $750 million in stablecoins to help stabilize the situation and strengthen the UST rate..
“Traders will trade capital on both sides of the market, helping to fulfill both the first and second goals, ultimately maintaining the parity of the LFG reserve pool (denominated in BTC) as market conditions gradually stabilize,” the organization stressed.
Soon after, the organization published its new bitcoin address and stated that it would continue to provide market makers with loans.
Meanwhile, the market continued to fall. The price began to fall on May 5, and by May 10, it had already tested support at $30 000. Furthermore, the prices of the majority of altcoins fell even faster. Panic was spreading throughout the market.
Because of the market collapse, UST lost its peg to the US dollar once more. The asset price fell below $0.62 on the night of May 10.
Jump Crypto, Alameda Research, and other organizations supporting the Terra ecosystem contributed an additional $2 billion ‘to save UST,’ according to Block analyst Larry Cermak. However, he believes that the only way to protect the asset is to make it completely secure.
Terra USD lost its peg to the US dollar once more on May 11. Its value has dropped below $0.23. The LUNA cryptocurrency used to create stablecoins has dropped by more than 80%.
According to The Block sources, LPG intends to raise $1 billion to stabilize the stablecoin rate. They claim to be correct. The organization was looking for financial support from “the largest investment companies and market makers in the industry,” and it also offered investors a 50% discount on LUNA.
Nonetheless, LFG’s attempt to attract funds ‘failed,’ according to Mikki Honkasalo, The Block analyst.
A researcher under the nickname Hasu compared the project to a Ponzi scheme, noting that ‘UST is worse than BitConnect’.
On May 11, Do Kwon presented a plan to restore the price of an algorithmic stablecoin.
According to him, an important step before taking other measures is to absorb the offer of UST holders who want to get rid of the asset.
The plan was to speed up the LUNA release.
According to the mechanism, 1 UST should always be available for exchange for $1 in LUNA. Kwon believes it will ‘help the system absorb UST faster.’
Because of market participants’ concerns about hyperinflation, the LUNA price fell below $1, and UST gained a foothold at $0.5. The price of the Anchor flagship project token (ANC) fell as a result of the loss of trust in the ecosystem.
Major South Korean crypto exchanges reacted to the sharp drop of the LUNA price: Coinone suspended trading in the asset, Korbit and Bithumb issued warnings to investors.
The perpetual contracts for LUNA calculated in the underlying asset have been delisted from the Finance Futures cryptocurrency derivatives platform.
Rumors circulated that BlackRock and Citadel Securities borrowed $100,000 BTC from the Gemini exchange and exchanged it for 25,000 BTC for UST. They allegedly contacted Do Kwon and stated that they were going to sell a large number of bitcoins, offering him the opportunity to purchase a large number of cryptocurrencies at a discount for UST.
Then BlackRock and Citadel allegedly dumped assets, causing UST, LUNA, and the entire market to collapse.
“BlackRock and Citadel knew that Anchor, which owns an impressive amount of LUNA, is a Ponzi scheme, and this collapse will lead to more withdrawals than Anchor will be able to repay. This will provoke a massive sale of LUNA, which will lead to a decoupling from $1 and further destruction of the market. Now BlackRock and Citadel can buy bitcoins cheaply to repay the loan and get the difference,” the theory says.
It was distributed by Charles Hoskinson, the head of IOHK, among others. He later deleted the tweet and noted that the rumors were not confirmed.
Gemini exchange stated that it did not provide a loan of 100,000 BC to institutional counterparties.
The rumors about BlackRock’s involvement in the collapse of the stablecoin were “categorically incorrect” according to the company, which does not trade the asset. Citadel also stated that it does not deal with stablecoins such as Terra USD.
Terraform Labs proposed a number of additional measures to restore the ecosystem on May 12, when the price of LUNA was already around $0.05. One of the initiatives involved expanding the LUNA base pool and increasing cryptocurrency issuance, which allegedly would allow the required amount of UST to be withdrawn from circulation faster.
The network slammed the company’s policies. Some users argued that the latter would only accelerate the ecosystem’s “death spiral” leading to the complete depreciation of LUNA.
According to Larry Cermak, Terraform Labs’ only way out of the situation is to abandon UST and focus on the development of the main network. He emphasized that as the ecosystem grows, the project team must repay the stablecoin debt.
The Anchor community has also prepared an “emergency proposal” which calls for lowering the target rate of return on UST deposits to 4% per year. According to its author, Daniel Hong, this step will prevent additional UST from entering circulation.
The outflow of funds from Anchor had reached nearly 9.5 billion UST at that point.
Terra developers have repeatedly suspended the blockchain, citing the need to protect the network from potential “management attacks” and develop a “recovery plan” for the system.
LUNA was trading just above $0.01 against the backdrop of the first suspension. Finance removed almost all trading pairs with LUNA and UST from the spot market on May 13, when the asset price reached $0.00006. Following that, the platform resumed trading these assets in BUSD pairs.
Terraform Labs’ “saving” measures resulted in the expansion of the LUNA offer to the astronomical mark of 6.5 trillion coins. This contributed to the depreciation of the project’s native token even further.
What is next?
The high volatility of LUNA has caused issues with displaying prices in the decentralized oracle network, which is used by many DeFi projects.
The Venus vending protocol reported a $13.5 million loss due to Chainlink oracle settings that prevent the LUNA price from being displayed below $0.1.
Subsequently, the Venus team temporarily disabled the protocol before launching the VIP-61 offer to zero out the security coefficient in the LUNA and UST markets.
A similar exploit was reported by the Blizz Finance protocol on the Avalanche blockchain.
At the same time, even the most liquid centralized stablecoin, USDT from Tether, deviated from binding. It is noteworthy that its competitor — the USDC — was almost unshakable.
The withdrawal of assets from Anchor, followed by the collapse of LUNA and UST, brought down not only the TVL of the Terra ecosystem, but also the aggregate indicator for the entire DeFi segment.
The unbinding of Terra USD, according to US Treasury Secretary Janet Yellen, highlighted the need to “create a regulatory framework for stablecoins aimed at minimizing volatility.”
Yoon Chang-hyun, a South Korean People’s Power Party representative, has called for parliamentary hearings on the recent collapse of the Terra ecosystem.
According to some reports, three Terraform Labs legal employees resigned following the demise of UST and LUNA. It was also revealed that LKB & Partners, one of South Korea’s leading law firms, is planning to sue Do Kwon.
What future does Terra have?
Obviously, the developers’ actions have exacerbated the situation around LUNA and UST. As a result, the native token experienced hyperinflation and the community lost faith in the project and the ecosystem.
Kwon proposed restarting the network with 1 billion tokens in the hopes of changing the situation. He stated shortly after the proposal’s publication that he was “heartbroken” because his invention caused a lot of pain to the community.
“I still believe that decentralized economies deserve decentralized money. However, it is clear that UST will not become such money in its current form” .
Kwon assured the community that neither he nor the organizations with which he was associated “received any benefit from what happened.” Terraform Labs’ CEO also stated that he did not sell LUNA or UST due to the crisis.
The project community proposed a hard fork and the creation of a new token. The latter can be distributed based on a network snapshot taken prior to the market collapse.
The initiative also includes the development of a new blockchain organization mechanism and the establishment of a pool for the repayment of the algorithmic UST stablecoin.
Changpeng Zhao, the CEO of Binance, questioned the Terra hard fork’s utility. According to him, the new chain will be worthless.
Zhao also questioned the use of the LFG bitcoin reserve. He claimed that the assets were supposed to be used to support UST.
LG representatives reported on May 16 that the bitcoin reserves are nearly depleted due to UST purchases. As of May 7, only 313 BTC remained out of a total of 80,394 BTC.
Many people were surprised that the massive “bitcoin interventions” had no effect on UST.
Some saw a silver lining in the fact that the first cryptocurrency did not crash after massive sales to save Terra.
On May 14, Ethereum founder Vitalik Buterin urged Terra to prioritize compensating small investors, echoing the sentiments of a Twitter user going by the handle PersianCapital.
A few days later, Do Kwon proposed holding a Terra hard fork in conjunction with the appearance of a new network and airdrop.
With the LUNA token, it was assumed that the new network would keep the name Terra. Terra Classic (LONG) and Luna Classic (LONG) will be the names of the first blockchains.
The total number of LUNA tokens issued will be one billion, with a 7% staking reward (inflation).
However, during the preliminary voting, the majority of Terra community members opposed the idea of a network hard fork.
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In conclusion
The Terra incident is without a doubt one of the most significant events in the history of the crypto industry. So far, no DeFi project has grown to such massive proportions before collapsing.
The community’s “rescue measures” only accelerated the collapse. The expansion of the LUNA offer to astronomical values had no effect on “absorption of UST” but instead caused hyperinflation.
The chances of escaping the “spiral of death” have become increasingly illusory, as evidenced by LFG’s nearly empty reserve fund. The question of whether it will be possible to compensate investors for their losses remains unanswered.
The future of the concept of algorithmic stablecoins is also uncertain, given the erosion of trust caused by Terra’s demise. The developers of some projects, including the Tron-based USDD, have stated that they will not close this door. All new algostablecoins, on the other hand, lose their binding.
If Terra can be reborn, the journey will be long and difficult. After all, the main issue is restoring user trust, not the technical component or the mechanism of binding to fiat.
