- On-chain selling – Curve pool imbalance
- $350m UST was swapped for USDT using the Curve protocol. This left a disproportionate amount of UST versus other stablecoins in the pool for users to swap against, lowering the value of UST on-chain
- Curve is a crucial piece of the DeFi ecosystem, allowing users and dApps to efficiently swap stablecoins. The massive selling of UST on Curve created an imbalance in reserves, leading to the value of UST falling below the peg on the protocol.
- Off-chain selling
- The remaining portion of UST withdrawn from Anchor protocol was sold on centralized exchanges like Binance driving down the value on those markets as well
LUNA’s price decreased by nearly 60% as UST was redeemed for Luna and sold for dollars – as traders profited off the arbitrage mechanism.
Trading firms like Jump Crypto initially tried to restore the peg and rebalance the Curve pools by swapping ~$270M USDT for UST, but could not keep up with UST outflows from the pools. Separately, an unidentified wallet was also swapping increments of 1000 ETH to rebalance the UST pools every few minutes in an attempt to further defend the peg, totaling more than 30k ETH sold at the time of writing.
On Sunday, May 8th, the Luna Foundation Guard deployed its $1.5b in Bitcoin reserves and UST to maintain the peg. Trading firms have been tasked with deploying $750m in BTC to defend the peg and $750m in UST with the goal to repurchase the sold Bitcoin once stability returns.
Both of these attempts proved unsuccessful and the UST peg continued to drop, reaching a low of 61 cents around 8 pm EST on May 10th due to the scale of the run. At the time of writing, the peg is back up to 81 cents as the arbitrage mechanism continues to operate in the background.
Attempts to restore the peg by selling Bitcoin and Ethereum exposed a crucial point of weakness in under-collateralized stablecoin models. If the price of the collateral backing the stablecoin supply suddenly tanks, the peg becomes increasingly harder to defend as you’re forced to sell declining assets.
What Does the Future Hold for Algorithmic Stablecoins?
This incident raises questions about the future of stablecoins on-chain, however, the design of UST as an under-collateralized and demand-driven stablecoin is nothing other than an emulation of the US Dollar.
While there may be challenges with projects like UST on Terra (LUNA) network or USDN on NEAR network, the push to continue innovating on-chain protocols and services remains important to the development of the broader crypto ecosystem.
Fiat-backed stablecoins, like USDC, have taken the path of least resistance to bring US dollars on-chain. Collateralizing the token 1:1 with dollars or treasury bonds means that the market simply needs to agree that the collateral is there, rather than speculate on the changing value of the underlying collateral.
Regardless of whether the price of Bitcoin falls further or skyrockets , builders will continue to innovate on the next iteration of stablecoins, taking into account lessons learned. For now, MakerDAO remains the premier decentralized stablecoin with over-collateralized crypto reserves backing the DAI stablecoin. The race to develop the first under-collateralized stablecoins remains to be won as projects like USDN on the Near Protocol or Frax Share on Ethereum gain popularity.
While UST has yet to return to peg, members of the Terra ecosystem are working hard to return the asset to $1 and reclaim some of the value lost this weekend. UST provided much of the on-chain liquidity on DeFi protocols, so we may begin to see second and third order effects if it fails to stabilize. However, as Barry Silbert pointed out on Twitter, most stablecoins that have lost their peg, eventually find themselves back at $1. We’ll see if this is the case with UST.
1 Peg – A dollar peg is when an asset intends to maintain a fixed 1:1 exchange rate to the U.S. Dollar.