Terra (CRYPTO: LUNA) and its native stablecoin TerraUSD (CRYPTO: UST) brought each other down in a cryptocurrency market catastrophe that would not be easy to forget.
What Happened: Market data shows that Terra's price fell by over 97% from Wednesday's intraday high of $33.2 down to a low of $0.8755, before correcting to about $1.5 as of the time of writing. Algorithmic stablecoin UST lost its peg to the United States dollar in a similarly spectacular market movement, falling off its peg by over 70% as low as $0.2998 and trading under $0.40 as of press time.
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Terra's collapse vaporized nearly $11.7 billion of capital in mere hours as the token's market cap shrunk from $12.24 billion down to $555 million. Similarly, TerraUSD's market cap lost nearly $14 billion when its market cap fell from its 24-hour high of $18.8 billion down to today's low of $4.91 billion.
Additional damage in the markets, is yet to be estimated, with Terra's fall resulting in liquidations worth $106 million; data showed that 58% of traders were placing futures bets on higher LUNA prices, according to data from Coinglass.
The wider crypto market is also facing a similar situation, with Bitcoin's (CRYPTO: BTC) 24 hours liquidations at $203 million and Ethereum's (CRYPTO: ETH) at $171.8 million.
Benzinga's Take: The most likely explanation is a runaway reaction in the precarious market system maintaining the peg of the UST stablecoin. As Benzinga reported on Sunday, Terra lost 20% of its value that day and UST saw its market shrink for the first time in the last two months after a whale — crypto speak for big holder — dumped $285 million of UST on a decentralized finance (DeFi) protocol. Some alleged that the dump was part of a coordinated attack on the protocol that coincided with an increase in tweets sowing doubt about the project.
Terra and TerraUSD have a very close relationship, with every UST being backed by LUNA. To mint UST you have to burn $1 worth of LUNA, but you can also burn $1 of UST to mint $1 of LUNA. TerraUSD leverages crypto-economic incentives to maintain its peg: when UST is worth more than $1, you can still buy it for $1 of LUNA and sell it on exchanges at a profit. When it is worth less than $1 you can buy it on exchanges and burn it for $1 of LUNA to sell. This mechanism is meant to ensure price stability, owing to arbitrage.
When the market confidence in UST is lost severely enough and the token ends up under its $1 peg, arbitragers inflate Terra's supply by minting LUNA at a discount — all the while the demand is stable or falls due to a general loss of faith in the project. A chart by crypto data firm Messari shows that Terra's supply skyrocketed by 9.6% from 345 million LUNA on May 11 up to 378 million LUNA while arbitragers exercise continuous selling pressure to buy more UST to sell again, lowering the price further and having everyone else flee in panic as well.
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