What Is UST

UST is an algorithmic-backed stablecoin native to the Terra Ecosystem. It operates using a seignorage shared model with LUNA absorbing the volatility of the UST stablecoin. This model achieves stability through a mint-and-burn mechanism:

When UST trades at >$1, 1 dollar of LUNA is burnt to mint 1 UST to increase the supply of UST and therefore pulls back the price. On the other hand, when UST trades at <$1, 1 UST, it can be burnt to mint $1 worth of LUNA, decreasing UST supply and bringing it back to the $1 peg.

In recent weeks, the Luna Foundation Guard (LFG) executed moves to add BTC and AVAX reserves to support LUNA’s role in backstopping UST’s peg to US Dollar.

What Happened

1. In March 2022, the Luna Foundation Guard (LFG) started to buy Bitcoin as their reserve to protect their algorithmic stablecoin, UST.
2. Speculation has it that the attacker sold BTC while LFG was buying BTC to strengthen the stability of UST.
3. The attacker bought $1 billion worth of UST in the OTC market.
4. On May 8, LFG withdrew $150M of liquidity from the 3Pool in Curve to boost the liquidity in the 4Pool.
5. As soon as LFG withdrew the liquidity, the attacker drained the 3Pool-UST liquidity by swapping $350M UST for 3crv tokens.
6. As the investor of Terra and the top-tier HFT firm in the world, Jump Crypto started to build a thick buying order wall at $0.98 to protect the price of UST, but in vain. On May 9, The attacker dumped the remaining $650M UST in Binance. UST reached $0.6 the next day morning.
7. People started to panic sell. LFG kept repurchasing UST, and the mint-and-burn mechanism of LUNA-UST was working. The price went back to 0.95 at some point.
8. The selling pressure was still heavy, and LUNA & UST had fallen into a death spiral. Both of their prices were dropping, which made matters worse.
9. The Block reported that Terra sought another fundraising with prominent VCs to survive the attack. However, the fundraising failed.
10. Do Kwon, the founder of Terraform Labs, posted a tweet about how TFL will save UST. The only thing they could do was accelerate the speed of minting and burning for LUNA-UST. No extra capital can be raised to protect the project.
11. On May 13, 2022, The price of Luna dropped to $0.0000199. The Terra blockchain halted several times as the validators are discussing the possibility of a fork
12. The price of LUNA soared to $0.0005 on some exchanges on May 14, becoming a meme trading pair since people are unsure of how this will end.

Our Measures

Before these events trespassed, we deployed a portion of our funds into Anchor Protocol, and as a result, three products incurred losses due to the de-peg of UST.

May 8th, 2022

We first spotted the abnormal de-pegging situation in Binance and Curve. The price was around 0.995 at that time. Since the pegging, the mechanism was still working, and by providing a total of $1.5 bn of loans to top market makers to backstop the price of UST, we believed that LFG is making the right moves to protect the ecosystem. For this reason, we decided to monitor the price a bit longer.

Do Kwon 🌕 on Twitter: “1/ The LFG Council just voted to deploy 1.5B in capital (0.75B in BTC, 0.75B in UST) to allay market concerns around UST. Some more context on why and how: https://t.co/TfaAPkzgUJ

May 9th, 2022

The price fell to 0.98 on Binance, and Jump Crypto deployed a large amount of capital to protect the peg. By design, the BTC reserves that LFG was holding would be used if the price falls below 0.98. We believed the >80k BTC reserves would withstand the selling pressure even if the key level did break.

May 10th, 2022

In the morning, UST dropped to an all-time low level of $0.6. Jump’s capital deployed did not withstand the attack, and the panic sell. The price bounced back to around $0.9-0.95 quickly. We decided to sell most of our positions in UST at $0.9 to avoid a more significant loss in our portfolio.

May 11th, 2022

The Block reports that LFG is seeking another fundraising with Celius, Jump Crypto, and 3AC, in the hope of surviving this event. The price of UST continued dropping, going as low as $0.22 on May 11. At that moment, LUNA dropped to $3, and UST was hovering between $0.4 and-0.5. Because the market cap of LUNA could not support UST to go back to peg, we decided to sell the remaining position at $0.48.

Afterward

UST didn’t go back to peg afterward, and the price of LUNA just kept dropping. On May 15, LUNA was trading at $0.00032, mainly because the mint-and-burn mechanism was still working, so a lot of LUNA was minted and sold on CEX/DEX immediately to save the peg of UST. UST is now trading at 0.12.

The fundraising failed eventually. LFG proposed to accelerate the mint-and-burn process by minimizing the spread fee in burning UST; however, at this point, it became impossible to salvage the situation.

Terra’s Recovery Plan

Terra has one of the strongest communities in the crypto space, and many solid projects were built based on Terra, so various options to achieve a soft landing for Terra have been discussed a lot, including:

1. A fork to Terra blockchain
2. Issuance of long-term bonds for UST holders
3. Use the LFG remaining reserves to buy back the UST of the smallest holders.

On May 16, the LFG announced that they would take the third option. Their reserves include the following assets:

• 313 BTC
• 39,914 BNB
• 1,973,554 AVAX
• 1,847,079,725 UST
• 222,713,007 LUNA (of which 221,021,746 is currently staked with validators)

The last hope of the pegging of UST that people were holding on to is now gone. A combined $84M of reserves will be used to repurchase some portion of circulating UST. The price of UST plunged $0.09 on FTX afterward.

What Does This Mean for our Customers?

Customers of OMO farming, OMO VIP USDC Core, and OMO farming Polygon have suffered some loss (mostly around 5%) due to the UST de-pegging event. In light of the turbulent time in the DeFi market, we decided to unwind all investments when their respective term is up and return the funds to the customer’s yield plan balance. You can choose to redeem the balance to your wallet, and we will process it when the current product terms are up and return the balance to your wallet as early as possible.

How Will This Event Affect the DeFi Space

Terra’s UST collapse is one of the largest crashes in crypto history, and it has shattered the foundations of the algorithmic stablecoin market. Ever since the collapse, Many algorithmic stablecoins with similar models have suffered different degrees of depeg. Even USDT, the largest collateralized stablecoin globally, depegged around 10% on May 12 before it quickly recovered.

We expect many algorithmic stablecoins will also suffer since they are undercollateralized, and the market sentiment will drive most of them, if not all of them, into the same death spiral over and over again. In the short term, the only stablecoins that the market will accept will be fully backed by fiat currency or over collateralized assets and transparent financial disclosures.

One can certainly argue that the UST event has caused a lot of fear in the crypto world. With inflation and expected hikes in interest rates, the deteriorating macro environment only makes matters worse. We expect a substantial portion of capital will outflow to safe-haven assets in the short term, making the bear market last a while.

Over the past few years, we’ve seen some extraordinary progress in the industry; many innovations like AMM, veTokens, and structured products popped up, and many highly successful projects have already existed since the last bull run. However, builders are going to build even in the darkest hour. There are still many opportunities in this industry, and we are ready to grab them.