Crypto Now: The Collapse of UST / LUNA

This is the market update. We have to talk about the Luna UST situation, how that’s affecting Bitcoin and Ethereum, obviously the huge sell-off in markets in general. How that has sparked one of the biggest blow-ups really potentially in crypto history, which is the LUNA UST?

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Let’s talk about some of the ramifications of this, you know, how LUNA will come out the other side of this. If they are to come out on the other side, they must increase the selling in LUNA by 70%. That makes sense because, like LUNA Terra LUNA, this token right here is actually used to essentially fund UST as well. This should be sold off because basically what they’re doing now is trying to gather as much value as possible to back up what is supposed to be a dollar and it’s not trading at that. It traded down to about 60 cents on the dollar. There’s a huge amount going on. I’ll try and explain the whole thing right here.

Essentially, what happened is people started selling off UST. There was a big kind of attack from some big players in the industry that sparked the big fear of uncollateralized stable coins, which is a run on the bank. When you start seeing the dollar peg falling a little bit, everyone starts to get a little bit scared. They withdraw their own capital from that. They sell UST for something else, either USDT or USDC, or something like that. So you’re getting massive selling of UST and so more and more selling, more and more selling, the peg fails. Obviously, that is contagion, and what you’re seeing here is anchor protocol, where so many people have just earned that 20%. That is just unseen, right? This obviously means people are taking their money out. People are selling. People are getting off the platform. This was obviously a huge contagion.

Here’s how it works. What happened with the dPEG? What happened when Bitcoin and Ethereum were sold? So if you know how LUNA works, they made a big stink about buying Bitcoin to back the peg of UST that has just completely failed. That was naive to say the least. Do Kwan signaled to the market that he was essentially going long Bitcoin with other people’s money. He was going along at $40k, $42k, whatever it was. The market, with much bigger bags, could just sell him all the Bitcoin that they had waited till he was full, dump the price, and obviously force him to sell at a loss, which is what happened. Here’s how LUNA and UST work:

UST is a decentralized stablecoin, which means it is not backed by dollars in a bank account, usually with something like USDT or USDC. We had some concerns about it. In any case, with USDC, they have a dollar for every dollar stablecoin that they have. The USDC has a circulation of 50 billion dollars. That means they have that much money in a bank account in the United States, either in cash or close to it. They’re called near cash instruments. They are very, very short-dated debt. We’re talking about three months, one month, three months. So basically, cash. They’re called cash instruments because they’re extremely liquid and have an extremely short duration.

That doesn’t happen with LUNA and UST, so the value of LUNA backs us. And there’s a big mechanism that tries to keep this peg hap in place, which I’ll go over very simply now. Essentially, what you do right is take your dollar and you buy UST. So they give you one dollar of UST.

Where does your dollar go? It doesn’t go into a bank account, of course, because this is decentralized, there is no bank account, so it has to go to a kind of crypto bank account. That’s what they do. They essentially take your dollar and what they do is they go and buy one dollar of LUNA off the market, right? So that obviously pumps the price of LUNA up. Every dollar that flows into UST is essentially a dollar flowing into LUNA. Of course, that pumps the price.

The way this mechanism works is that if you want your dollar back, the LUNA is sold to the market, who then returns it to you. You can then send that out to your dollar amount. The problem here, and probably with every other state you know, decentralized stable coin, is that this is a risk asset and so it can be moved around and it can change with daily supply and demand and characteristics.

One of the possible downsides of a decentralized stable coin is that the value of the stable coin or the value of the reserve fluctuates. The base asset doesn’t back the entire value of the dollar, and that’s what’s happened. Terra LUNA is worth ten and a half billion dollars. As you know, the market cap for Terra UST is worth 16 billion dollars. So here’s a problem. You have people holding dollars with a value of 16 billion, and there’s only 10 billion dollars to fund that. That’s an issue. That’s like having fewer dollars in the bank than you owe.This is an impossible situation now. This has happened as a result of the huge selling of UST. This is the open market position of LUNA, and there is a circulation of this. Why this is here is because, essentially, the Luna Foundation Do Kwan obviously has a bunch of tokens. The Luna Foundation Guard, as they named themselves, has a ton of LUNA as well. That was obviously pumped up in price by people putting dollars in. You have this situation where there’s a lot of open market LUNA. There’s also LUNA that’s controlled by a small party of people that essentially use that to try and invest in assets that also back the peg of this one dollar. What they did was go and buy BTC or at least an amount of it.

 Their plan was never to just buy a one-to-one amount of Bitcoin with UST. They basically said, “We want to buy a few billion dollars’ worth of Bitcoin to back the peg to ensure liquidity around this one dollar.” If there is an attack and a large number of people suddenly want to sell out, and there is a liquidity event, we have a few billion dollars’ worth of very liquid Bitcoin to sell right away to shore up the peg. We have to make sure that even if there’s a liquidity event, we have enough liquidity there to keep the peg at one dollar. There won’t be any contagion. There won’t be any panic from other people trying to all sell out at once. Obviously, that didn’t work.

So I’ll now come to an article from this twitter account. It’s his work, not mine, so a great account of, you know, what was happening at the time and the on-chain was just obviously telling a really big picture, which is summarized. Obviously, you have big liquidity pools around crypto that have a lot of different stable coins in them, and that was part of the success of UST in attracting a lot of liquidity. They went out and got this liquidity via various methods, both social and getting a lot of attention and hype and also just having a lot of liquidity there because, really, this was one of the best ways to attract money to one protocol itself. One of the most difficult things in crypto is to try and attract money to your protocol. Well, this was like the dream of all dreams because it was just direct dollars. It was like someone’s going to give you one dollar right into your token right now, and you just have all of this cash sloshing around. People were attracted to that.

So what you can see above are the curve pools where a lot of the liquidity and trade between UST and other stable coins takes place, namely USDT and USDC, and diet as well, I believe, and fracks, so they’ve added some in. As you can see down in the bottom right, the proportion of us in blue compared to the others, is obviously going through some big events right here and that’s what shouldn’t happen. So, as you can see, someone was basically carting us into this liquidity pool, right selling it into the pool and getting out of the USDT/USDC, which was causing an imbalance. Obviously, that’s not good. That means something is wrong. When there’s an imbalance like this.

So, LFG or whoever is kind of backing this project sent 50 000 ETH to an exchange to basically sell for USDT, and some other dollars to reduce the imbalance in the pool. 50 000 or so ETH shares were sold and another 20 000 were sent to Binance. That is a ton of money. One ear costs around three thousand dollars. This kept the UST pegged, but it resulted in hundreds of millions of dollars in on-chain export sales and who knows how much on Binance. That’s a centralized exchange, so you can’t really see that, so what they’re saying is that whoever this is has Ethereum and they’re dumping Ethereum on the market. Hence, why do you see both Ethereum and Bitcoin coming down? Because it was happening around that too, you know. That obviously restores liquidity to the US dollar tether, which they were using to essentially buy UST in order to maintain the one-to-one peg.

You can see here exactly how it happened. The UST in blue versus the other stable coins in the pool in orange. You can see that it was just, you know, de-pegging. There was a massive sale of UST. You can see here as it comes back down that they were basically carting Ethereum to the market, selling it for those stable coins, and then rebalancing, essentially buying Ethereum on their books to try to keep the peg. You can see it actually did work. It comes down to more or less parity. That’s obviously good. What they wanted to do was keep UST, but this is hundreds of millions of dollars’ worth of liquidity that they’re trying to pour into this to save the peg of UST. As you can see, obviously it doesn’t work, but then it happens again.

You get another event, more selling of UST. This is when the address (i. e. Hero #2) came in and fixed the problem with a quick $250 million in additional liquidity. that liquidity coming from? Probably Ethereum sales, maybe some LUNA sales, big LUNA sales coming in. They’re selling LUNA to get the other stable coins in order to sell them to buy more UST to try and keep parity again, and it actually worked again. You’re pretty blunt, right down to parity again.

You’ve got the sellers of UST trying to force it into huge liquidations, and then twice, LFG or whoever it is, has bluntly gone and sold Ethereum to, you know, those other stable coins to try and, you know, get it back to parity. Consider this: hundreds of millions of dollars spent on chains have essentially rendered UST toxic debt. The people that were selling Ethereum at whatever price were dumping the price. Therefore, the whole Ethereum ecosystem comes down. They are selling that for USDT and then taking USDT and buying UST. UST is now toxic debt because there is a run happening on the bank and people are selling it, and so you know, the chances you’re buying UST here at, you know, 98 cents on the dollar, 97 cents on the dollar, how are you going to get your dollar back where it’s going to keep going lower? That’s why it’s called, you know, toxic debt, right, because there is no buyer for it.  This is when the final attack began. At this point, just on chain, there were 580 million dollars of unsellable UST in Hero2’s address, so they were just buying UST over and over and over again.

The third attack happened. This was probably more than just the attacker, or whoever that was, but also the market itself. Lots of people that own said, “Whoa, this is scary and I’m just outright scared.” So you get a lot of people trying to sell all at once. You get this run. This is a run on a bank. That’s exactly what it is, so it’s just completely de-pegging overall when you see this thing’s supposed to be a dollar and it’s just this huge amount.

For the most part, it has recovered some of this, but the amount of money that it has taken to try and prevent it has obviously completely overwhelmed the LUNA ecosystem. At a certain point during this de-pegging event, it looks like LUNA basically gave up trying to keep the UST peg anywhere near, you know, parity at a dollar. And that’s quite clever actually, because what you’re doing is to UST sellers, especially whoever or you know, whomever, maybe a group of attackers, on this, you’re lowering the price that they’re selling UST at, and obviously they’re making less money. They’re getting into kind of a worse position every time, you know. You could let them sell for as little as 80 cents or 70 cents, something like that. You know, if they’re shorting your UST, you then wrap that in their face, so you’ve heard of short coverings, where people go short and then they’re actually in a losing position and they need to buy back their shorts, and that’s where you get these short coverings and big, you know, rises. That’s potentially what they’re doing here as traders saying, you know, if you want a short UST, you can do it, but we’re not going to let you short it at 98 cents. We’ll let you short it at 70 cents and then we’ll use our liquidity there to try and get you to short cover and kind of raise the price back up. That’s jUST what kind of trading can happen, and, you know, that’s probably what these traders did.

So that’s how the kind of trading happened and how the deep EGG happened and how it was just completely unsustainable for LUNA to just keep chucking billions of dollars at this because it was obviously obvious that the kind of market itself had more liquidity to sell than they could absorb, but where do we go from here because a stable coin is supposed to really just be trust and that’s really all there is to it. It is one dollar for one dollar at all times, and how can you sell a stable coin on anything but pure trust? So that is obviously a question that we just don’t know the answer to right now. It’s still very early. You can see that the number of people pulling out of the anchor is obviously extreme right here. People just want their money out, which is obviously fair enough.

Now with the other varying events that have happened in the industry, what usually happens is that the stablecoin does actually recover to a certain point because, obviously, the people that have sold it, especially attackers that sell short, do have to cover their short back and then they will have to buy that back. You know, these deep egging events frequently become extremely violent but then recover to some extent, but obviously it’s about the future of what can be used as a brand as a stable core and actually carry on at this point, which we don’t know because LUNA was backing the peg with Ethereum and obviously a bunch of Bitcoin as well, which has all been sold out.

LUNA basically bought Bitcoin up here at $45k and probably sold a bunch at $31k. It’s just total carnage uh trade in a few weeks, from 45 they bought to 30 they’re selling to back the peg. I don’t know how much they have left, I don’t know how much they’ve sold, but they probably would have sold a good chunk. This is just a terrible trade right here. Funnily enough, what we’re seeing is a Bitcoin bounce today along with the stock market around this 30 level. This is unreal support right here. When we break through the 30 level, we can see that support is virtually non-existent all the way down to about 25, where the last kind of area of value really traded here at 20-22, 23-24. This is hopefully what’s going to happen, but obviously we don’t know that for now.

The dollar is actually recovering a lot now, back to about 90, so you know, anyone selling out now, you’re only making a 10% loss on that dollar rather than those guys down here, who were making a 40% loss. These things do recover. I think LUNA are really using their capital now to try and bring it back to the peg rather than defending it initially.

[This article is a transcription of a video made by MoneyZG]

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