The Great Terra Dip
Today marked the most troubled day in all of Terra history.
TL;DR
UST lost its USD peg, hitting an all-time low of 0.60 USD on Binance. The crash exposed a flaw in Terra's algorithmic peg: redeeming UST for LUNA only holds when LUNA's market cap exceeds UST's. With UST at 15B and LUNA at 12B, mass redemption collapsed both. LFG's 1.5B liquidity injection and Binance's 0.70 cap failed to stop it.
UST lost its peg to USD, trading at an All-Time-Low of 0.60 USD in Binance.
We’ll review the fundamentals behind Terra ecosystem and the timeline of events.
Fundamentals
The price of UST is pegged to USD by allowing people to reedem UST for an equivalent amount of LUNA: 1 UST is reedemable by 1 USD worth of LUNA, regardless of UST price.
Reedeming UST for LUNA increases the supply of LUNA and decreases the supply of UST (burns UST, mints new LUNA). This way supply-demand law, this will decrease the price of LUNA and increase the price of UST.
However, what happens if the market cap of UST is close to or higher than the market cap of LUNA, and everybody wants to sell their UST? (as in, today)
Lets imagine a situation where market cap LUNA = market cap UST and everyone uses redeems their UST. This would increase the supply of LUNA x2, inmediately halving its price. Thus, people would only get 0.50 USD for 1 UST.
Today, the situation is even worse than this, as market cap UST > market cap LUNA (15B and 12B USD).
Due to the insufficiency of this control mechanism against a run on UST with current market caps, the Luna Foundation Guard (LFG) added an extra control mechanism: when the time comes, they will hop-in and save the UST peg by deploying capital discretionally (+10B USD worth of BTC).
The time for applying this safeguard was today. A day with weaker and uncertain LFG reserves, due to falling price of BTC.
Timeline
- 6:40 PM (UTC)
With UST trading at 0.92 USDT, Do Kwon comes to the “rescue” by deploying more capital.
This means Luna Foundation Guard (LFG) injected 1.5B USD of liquidity into the market. Half of this capital was UST and half was BTC. It was sent to the Gemini exchange.
- 11:45 PM (UTC)
UST trading at 0.61 USDT on Sushiswap, forecasting the upcoming collapse on other exchanges.
At this time, UST was still trading over 0.80 USDT.
Attempts to arbitrage this price difference were curtailed by the over ~60 minutes waiting time to confirm transactions on Terra network
- 0:05 AM (UTC)
The price of UST keeps falling.
Binance sets an artificial cap 0.70 USD on UST: you were unable to buy/sell UST for less than 0.70 USD.
As UST keeps falling below 0.70 USD, it trades at this artificial price on binance.
Minutes later, Binance was forced by the market to release the cap. This cap lasted 10 minutes.
- 0:20 AM (UTC)
UST reaches All-Time-Low of 0.60 USDT
Update:
- 2:30 AM (UTC) At time of writing, UST is trading at 0.78 USDT on Binance
Frequently asked questions
How was UST supposed to keep its peg to the US dollar?
UST maintained its peg through an algorithmic mint-and-burn mechanism: 1 UST was redeemable for 1 USD worth of LUNA regardless of UST's market price. Redeeming UST burned it and minted new LUNA, contracting UST supply and expanding LUNA supply. By supply-and-demand, this was meant to push UST's price back up toward 1 USD.
Why did the algorithmic peg mechanism fail during the crash?
The mechanism only works when LUNA's market cap comfortably exceeds UST's. During the crash UST's market cap (15B) was larger than LUNA's (12B), so a mass redemption would roughly double LUNA's supply and halve its price, meaning holders received far less than 1 USD per UST. This made the peg unsustainable during a run on UST.
What interventions were attempted to defend the peg, and did they work?
The Luna Foundation Guard injected 1.5B USD of liquidity (half UST, half BTC) into the market via the Gemini exchange while UST traded around 0.92 USDT. Binance also imposed an artificial 0.70 USD floor on UST, but the market forced it to lift the cap after about 10 minutes. Neither held: UST still fell to an all-time low of 0.60 USDT before partially recovering to 0.78.