Stablecoin Terra’s Peg Continues to Unravel

The unraveling of stablecoin TerraUSD’s (UST) peg to the US dollar continues unabated.

As of this writing, it is trading at $0.40, down 23.7% from its price 24 hours ago, according to data from Coinbase. That figure is a far way off from its $1 peg to the US dollar but still represents an improvement from trading lows of 23 cents to the dollar on Tuesday.  Meanwhile, the price of Terra’s sister token Luna is at $0.0151, a crash of 99.5% from the same time a day ago.

Luna’s steep fall might seem baffling to investors not familiar with Terra’s economics. The native miner token is used as a staking mechanism and is used to maintain Terra’s parity with the US dollar. Thus, it’s supply increases when Terra’s price falls below the $1 peg and it decreases when the peg rises above the $1. Traders can arbitrage Terra’s peg by exchanging a single unit of Terra for $1 worth of Luna.

There are no limits to Luna’s supply. In fact, the supply has skyrocketed following Terra’s loss of peg last week. According to Terra analytics, approximately 28.9 billion Luna have been minted since Tuesday, bringing the total circulation figure for Luna to 30.4 billion. Investors exchanging their Terra holdings for Luna have added to the selling pressure.  

Terraform Labs Outlines Measures

Terraform Labs, the outfit behind Terra, outlined three emergency actions on Twitter to revive Terra’s peg this morning. Together, the measures are aimed at boosting liquidity in the system and ensuring that the market capitalizations of Terra and Luna, which have reversed since last week, are in line to ensure Terra’s peg.

Terraform Labs said it plans to burn or remove from circulation significant amounts of UST from the community pool – a common pool to fund projects on the Terra blockchain – and Ethereum’s blockchain. Simultaneously, it plans to stake 240 million Luna tokens.

Approximately 11% of all UST will be taken out of circulation as a result of the proposal. According to the organization, the removal of excess supply of UST will “alleviate much of the peg pressure on UST.” The staking of Lune tokens is meant to preempt hijacking of proposals by malicious actors during a time when Luna’s circulating supply in trading markets has multiplied.

Pain for Investors

The crisis in Terra’s peg and the subsequent price crash has raised many questions about the economics experiments in algorithmic stablecoins. Eventually, however, it is investors in Terra and Luna who will have to pay the price of these experiments.

The loss of a peg is ordinarily a trading opportunity for stablecoin investors. The death spiral in Terra’s and Luna’s prices, however, has left them holding a bagful of losses. Terra investors can exchange their Terra for a dollar’s worth of Luna, when the former coin loses its peg, and sell it in the open market for a healthy profit at the latter’s trading price.

But an oversupply of Luna has crashed its price to less than a dollar. And there is scope for further devaluation. Terra co-founder Do Kwon outlined a proposal yesterday that aims to restore Terra’s peg by increasing redemption limits for Luna. Proposal 1164 boosts the number of Terra that can exchanged for Luna by as much as four times.

Complicating the situation further is the fact that Luna holders have a staking period of 21 days, meaning they cannot withdraw or sell the token before that time period. While there were rumblings about a crisis in Terra’s peg, it would have been difficult for traders, who staked Luna tokens recently, to predict the sudden turn of events three weeks ago.

Around three weeks ago, Terra’s 1:1 peg was firm and fixed to the US dollar and the coin had a market cap of $18 billion. The latter figure rose to a peak of $18.7 billion two weeks later. As of this writing, Terra’s market cap is $4.44 billion and its peg remains unhinged at $0.30 to the dollar. The situation is even more dire for Luna. Its trading price has crashed by roughly 99.98%.

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