Luna and Terra ecosystem falls
White Star Capital Digital Asset Fund - newsletter #83
Luna and Terra ecosystem recently collapsed. UST was meant to be an algorithmic stable coin behind the Terra ecosystem. UST was meant to hold 1 to 1 peg with the US dollar. Luna is the governance token of Terra.
White Star did not hold exposure to Luna or UST.
The algorithm allowed Luna token holders to swap for UST to maintain the peg. For instance, if 1 UST = 1.01 USD then LUNA holders would redeem 1 dollar worth of LUNA for 1 dollar worth of UST. This would bring more UST into circulation and bring the peg to 1 UST = 1 USD.
In the reverse case, if 1 UST = 0.99 USD then UST holders would redeem 1 dollar worth of UST for 1 dollar of LUNA. This would remove/burn UST from circulation and bring the peg to 1 UST = 1 USD. However in this case, the arbitrager would receive LUNA and sell it placing downward pressure on LUNA.
This was the algorithm mechanism of LUNA and UST stable coin. Now there are a couple more elements in play. The reason to hold UST was that users could earn 20% APY yields on a stable coin on Anchor protocol. What supported the 20% APY? Terra burned LUNA for UST. This bootstrapping method fueled the growth of UST by encouraging people to stake UST on Anchor for 20% APY, and then burned LUNA to support the 20% APY payout placing upward pressure on LUNA.
When UST to USD peg breaks there can be a spiral downwards. The peg was defended by the 1.5 billion in bitcoin that Luna Foundation Guard holds, LFG would sell bitcoin and buy UST to protect the peg. Yet arbitragers were able to break the peg by selling massive amounts of UST. Once the peg broke to 1 UST = 0.95 USD, UST holders continually redeemed 1 dollar worth of UST for 1 dollar worth of LUNA and sold LUNA in the dynamic above. This created hyperinflation of LUNA and massive selling pressure. Luna Foundation Guard attempted to defend the peg using all of its 1.5 billion of its treasury. LFG failed and LUNA price collapsed.
Luna fell due to a tail risk event. LFG can support the peg in a majority of cases but this time around it failed. However, we are seeing BTC and ETH hold their levels and push off a larger systematic sell-off.
🔦 White Star & Portfolio Spotlight
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