The reason Terra Luna crashed

I found this article and found it fascinating.

Unless you've completely switched off from crypto, or the news cycle for that matter, you're probably aware of LUNA losing 99.99% of its value in a matter of days. Terra Protocol and its two main tokens - UST and LUNA - went into freefall as a carefully constructed mechanism (supposed) hit a snag. And a big one at that.

To understand what happened, it's important to understand UST and LUNA's correlation in the Terra ecosystem. UST is a stable coin; however, unlike USDT (Tether) or USDC, it's not backed by cash, short-term US govt. securities, commercial papers, etc. UST is an algorithmic stable coin - it maintains its peg to the USD through financial engineering. Or at least it used to.

How Does It Work?

Terra made use of an arbitrage function to maintain UST's peg. The protocol has two pools - a LUNA pool and a UST pool - and each can be traded with the other. The key: 1 UST can always be traded for $1 worth of LUNA.

So, if UST loses its peg and drops to, say, $0.99, traders can trade a large quantity of it for LUNA worth $1 each, thus earning a profit of $0.01 on every token. Traded UST is burned in the process, further reducing the supply and increasing its price to $1.

Conversely, if UST's value rises to, say, $1.01, traders can trade LUNA to create UST and earn a profit of $0.01 on every token. UST supply increases and the price drops to $1 again. Also, traded LUNA is burned in the process, making it more valuable.

Furthermore, to incentivize traders to burn LUNA and create UST, Terra offered a whopping 19.5% yield on UST staking through the Anchor Protocol. Prior to the crash, over 70% of UST's circulating supply was staked in this protocol.

The Luna Foundation Guard (LFG)

To protect the peg further, Terra founder Do Kwon created the LFG, a non-profit that held a reserve fund of around $3 billion in BTC and other cryptocurrencies. Its job was simple - if UST dipped well below $1, the LFG would use the reserves to buy tokens and restore its peg.

If UST rose, they would sell UST and bring it back to $1, with the profit being used to replenish their reserves.

So, What Happened?

The catalyst began on May 7-8 and cascaded into Monday, May 9 - over $2 billion worth of UST was unstaked from the Anchor Protocol and hundreds of millions were sold immediately.

This huge selling volume pushed UST's price to $0.91. Traders rushed to take advantage, trading $0.9 worth of UST for $1 worth of LUNA. However, there was a hitch - only $100 million worth of UST can be burned for LUNA per day.

Consequently, UST couldn't retain its peg, and investors flocked to sell their stock, driving the price further down. This had a knock-on effect on the whole ecosystem and LUNA was dumped into oblivion.

The LFG quickly exhausted its reserves trying to restore UST's peg but in vain. Over a billion in BTC was sold in the process, triggering a sell-off and affecting the entire market. Billions of dollars in crypto value were wiped out within a matter of days.

This event further highlights the key tenets of investing: do your own research, give weight to fundamental analysis, and only invest money that you can afford to lose.

I took this word for word I hope this was helpful in understanding what happened.

On to what happened…

Do Kwon has had very publicized feuds with folks on

air and in the news that challenged the UST/LUNA.

He openly challenged parties to try and bring down

Terra. Do Kwon seems to have put a target on his

back with his behavior and was challenging parties

that were showing him the weakness in LUNA/UST.

Since markets have been extremely volatile over the

past few weeks, a downtrend in price and tightened

liquidity of crypto assets was created, forming the

vulnerabiltity that brought Terra down.

Here's the abridged play-by-play (thanks to Route 2 FI on Twitter):

Supposedly, Terra Labs had pulled $150M of UST

liquidity from 3-Pool on Curve to migrate over to

4-Pool - to help maintain balance and diversify

across another asset.

There was now limited liquidity in the active 3-Pool,

and the attacker exploited it

The attacker swapped $85M of UST to USDC

creating an imbalance in the pool

While all of this is happening, the attackers

borrowed 100,000 BTC to short (i.e. betting that the

price of Bitcoin will fall)

The attackers then buy $1B UST in an OTC trade

(peer to peer, over the counter)

Rumors and fear start spreading like wildfire and

deposits on Anchor, the protocol on Terra that

offered users a 19.5% yield on UST, start falling

~$10M every minute

The US markets begin to open in the red, further

exacerbating fear and weakness in the

macroeconomic environment, fueling the selloff in

crypto

To help fight the depeg, LFG starts to sell LUNA and

Bitcoin to restore it -> this leads to downward price

pressure on both LUNA and Bitcoin (remember the

attackers shorted Bitcoin)

This leads to the death spiral and the crazy unwind

we saw over the past few days

Attackers keep dumping UST sending LUNA supply

to 6.5 trillion

Bitcoin starts selling off due to massive sell pressure

LUNA price continues to fall, because of the re-peg

mechanism that continues to issue more LUNA

With all the events happening rapidly there was

massive chaos in the markets and the fear was

beginning to reach unsustainable levels

Now that the dust has settled...

Today, LUNA is halted on most exchanges from

trading and effectively $0 and the Terra blockchain

has shut down from processing any new transactions.

In my opinion, the trust has been shaken and it seems

unlikely Terra will be able to recover. Terra has

massive backers and partners that could help breathe

new life into the project and help them “fix” the

stablecoin mechanism, but with tightness in the

market and massive write-offs that many would have

likely endured this week, it is doubtful.

The events over this past week are very nuanced. One

thing is clear, billions of dollars were wiped out for

companies in the ecosystem, consumers that had their

savings in UST, and many others.

Luckily, Ember Fund has not included UST in any of

our portfolios due to some inherent risks we saw with

the asset. So rest assured when investing with us

Absolutely, only risk what you can afford to lose, as with all investments not just crypto 😀

I keep seeing people saying that Luna will recover. I don't see this happening

People are now seeing the sinking ship and don't seem to understand...they take it as an "opportunity" to reinvest into something that's never going to recover

I think your right, it will never recover, sadly 😌

Hopefully they will manange to fix and Luna will take off to the moon again 😂

Did you also invest in Luna?