What the f#ck, LUNA? Alright, let us explain.
Once the prize jewel of the crypto world, the Terra blockchain is little more than shifting sand now. Several investors have seen their funds erode in the mystic storm that swept the crypto space, particularly the Terra ecosystem. This has left several bemused and wondering what really transpired. If you are curious, this article should give you a low down on the unpleasant drama.
This investigation may seem as a slight off topic, but since it affects the NFT industry as much as it affects blockchain, we just couldn’t stay away.
UST Depegging – Foreplay
Before reeling out the unsavoury details, here’s an overview of the Terra blockchain.
Terra is a protocol from South Korean-based Terraform Labs, led by Do Kwon and Daniel Shin. The crypto project was launched in 2018 and was touted as a gateway into the flourishing decentralised finance (DeFi) ecosystem. Terra was not launched to compete with any established project but instead aimed to introduce stablecoins of major world currencies.
While other fiat-based digital assets were backed by real-world physical assets in banks and government securities, Terra’s stablecoins were algorithmic. As a result, there were no real-life assets backing the billions of dollars in circulation, just lines of codes.
Aside from the stablecoins, Terra blockchain was principally powered by the LUNA token which served as a weight balance for the myriad of stablecoins in its portfolio.
The workings of this process are complex, but we will explain it in a simple format.
To keep the dollar or fiat value of the stablecoin constantly pegged to their respective currencies, LUNA tokens of equivalent value are burnt.
For instance, if the value of UST (the most popular of the lot) is lower than a dollar, $1 worth of LUNA is burnt, and if the stablecoin goes above $1, the stablecoin is burnt to retain its 1:1 fiat ratio. Burning mechanism is a way of permanently removing a certain percentage of a token from circulation.
With this, the UST token and all other stablecoins maintained their balance. However, there is a third force at play. This third force is Terra’s most successful saving platform, Anchor Protocol.
The third force – Anchor Protocol
Anchor Protocol allows users to save their UST token for a 20% annual percentage yield (APY). The saving platform was quite successful with over $14 billion in total value locked (TVL) recorded at one time.
The high yield was a huge draw, but the cracks were already showing. The most notable crack was a governance proposal filed by ‘N3m0’, who pointed out that the high yield promises to depositors were unsustainable.
He called on the newly founded Luna Foundation Guard (LFG) to shore up the decentralised yield protocol’s reserves with $450 million to keep its 20% APY ongoing. The idea was to carve out more time to launch a new and improved Anchor V2 iteration. LFG heeded this plea, with Do Kwon cryptically tweeting, ‘Funded’.
But this was a temporary reprieve, as events in the following weeks revealed. The protocol’s reserves soon dried up, with the Anchor Yield Reserves dropping from $323 million to $176 million within a month.
To forestall the continued slump of the yield protocol, venture firm Polychain Capital and asset manager Arca proposed that deposits above 100k UST should be reduced in a now redundant governance proposal.
The idea was to institute a variable yield rate. Hence, 100k UST deposits will be paid 19.56% in yields while higher deposits would get 17.5% and deposits above the $500k mark would receive 10%. However, this proposal was opposed by community members, with three-quarters of the vote against the sustainability drive.
Another proposal tagged Dynamic Earn Rate was tabled on March 2.
A prominent opposition was Twitter user ‘Westie’, who told his 11k plus followers to vote against the proposal.
As contained in the bombshell thread which subsequently followed, Anchor Protocol was meant to offer a fixed interest rate instead of other yield protocols.
With it being apparent to its numerous institutional investors that the fixed interest rate would no longer be feasible, the house of cards came crashing down rapidly.
One of the first to jump ship was crypto lending protocol Celsius Network, which reportedly pulled its $500 million deposits. The move was captured in research by blockchain analytical firm Nansen, which debunked the growing narrative that a popular hacker or attacker led to the debacle.
Following this chain of unsavoury events, the UST stablecoin, which served as the life-blood of the Terra and Anchor Protocol ecosystems, began to lose its dollar peg. Soon after, the algorithmic stablecoin dipped to $0.9720 as reports of large UST withdrawals began to hit the internet.
Actions to Maintain Repeg
To keep UST pegged to the dollar, the LFG switched into action. Here’s a quick background though. Luna Foundation Guard was formed to further shore up the dollar peg of the UST and LUNA token.
The foundation bought $1.5 billion worth of BTC (40k BTC) at the time and had $3.5 billion in disposable funds. The idea was to serve as a forex reserve for its assets.
The LFG team began selling off its BTC holdings to stop the downward spiral, but this had little effect. The Terra reserve exhausted its 40k BTC holdings with no marked changes in the downward slump of the UST stablecoin.
The digital asset soon dropped below a cent, hitting a lower low of $0.00066 at the height of the panic. UST was not alone in its downfall as the principal token for the Terra ecosystem, LUNA, lost 99.99% of its value during the aftermath.
This was because the Terra team began minting even more LUNA to regain a repeg of its stablecoin. With so many tokens in the market, the price action of the one-time sixth most valuable digital asset by market cap dipped from $120 to below $1 within the space of a week.
Despite their best efforts, Terra’s founder Do Kwon realised that the ship had set sail and could not be anchored again. Several investors lost billions in UST and LUNA investments and this prompted him to table a solution: Terra 2.0, a new blockchain with no record of the debacle and a clean slate.
Termed Terra Ecosystem Revival Plan 2, the proposal obviously omitted a principal asset, its UST stablecoin. Kwon proposed the retention of the LUNA token and the continued operation of the former blockchain, with its token name, switched to LUNA Classic (LUNC).
The project has since launched with several top exchanges supporting the new token. As a way of supporting investors who lost their funds in the previous blockchain, the Terra team launched airdrops with LUNC holders able to get a fraction of their funds in LUNA tokens.
These airdrops have largely been cashed in since LUNA’s launch. The digital asset started trading at a height of $19 but soon slumped below the $4 mark.