The primary concept behind a stable currency was that it was linked to something like the US dollar, gold, or another financial instrument by using them as deposit collateral and using an algorithm to control demand and supply.
People will want reliable assets from which they may transfer money to other parties with lower fees if you want a big number of transactions.
As we all know, cryptocurrency is a highly volatile asset, hence many are looking for stable alternatives.
Let me explain all the jargon before what happens in Terra Luna.
Take a look at the chart below, which dropped from 128$ to zero in a matter of days.
The largest robbery in the crypto world recently happened, wiping out roughly 100 billion dollars from the crypto world, with about 40 billion dollars from Terra Luna.
This article will highlight algorithmic stable coins, what goes wrong with them, and how the Luna coin crashed to zero in a matter of days.
Let me start by explaining what a stable coin is in the crypto world?
What are stable coins?
Types of stable coins :
- Fiat – collateralized stable coins: It maintains the reserve of fiat currency (USD or other currency) as this reserve currency assures a stable coin value.
- crypto – collateralized stable coins: It is pegged or backed by cryptocurrency to assure the stability of the coin as we know that crypto is highly volatile so the collateral value of crypto is higher than the stable coin issued in the market.
- Algorithmic stable coin: Reserve assets may or may not be held by algorithmic stable coins. The technique of keeping the stable coin’s value stable by restricting its supply through an algorithm, which is effectively a computer software running a predefined calculation, is the main difference.
Now, let me explain what is Terra, Luna, and UST?
Terra is a blockchain network, similar to Ethereum. Its protocol was created to achieve constant pricing using algorithms, and its primary goal is to create a mass payment processing system.
Terra has a native token which is called Luna token just like the Ethereum network has a native token ETH.
Why Terra project was built?
As we all know, VISA, MasterCard, American Express, and other existing cards charge huge fees on transactions; however, terra transaction fees are significantly reduced.
The Terra blockchain has a stable token for numerous fiat currencies, such as the US dollar (UST), the Korean won (KRT), and the Euro (EUT).
There are two coins in the Terra ecosystem:
- The first is LUNA, which is a native token.
- The second is a stable coin known as UST.
LUNA’s use case differs from that of previous projects because it is used to keep Terra’s value constant.
Let me explain how this mechanism works.
If the UST price is greater than one dollar, you can lower the UST price by producing more UST.
To raise the number of UST on the market, you must burn the LUNA token, for which you will receive a reward of 1 UST plus a small profit.
If the price of UST is less than $1, people will burn or destroy it, raising the price of UST, and you will be rewarded as a LUNA.
You must burn UST to remove it from the market, for which you will be rewarded with 1 LUNA and a small profit.
You may have noted that I indicated small profit, and that’s because they’re hunting for arbitrage opportunities in this transaction.
let me explain this to you with an example :
Assume Vishal purchases 100 Cr of UST on Binance, and the value of UST rises from $1 to $1.01 on Binance as a result of this transaction.
Tushar is monitoring the price of UST rise to 1.01$, then Tushar buys 1$ of the LUNA token in Terra Ecosystem, burn the LUNA in exchange for 1UST, which is valued at 1$, and sells the UST on Binance for 1.01$ profit.
Let’s assume Vishal sells 100 Cr of UST on Binance, and the value of UST declines from $1 to $0.99 on Binance as a result of this transaction.
Tushar is watching the price of UST drop to 0.99$, so Tushar will buy 0.99$ of UST from Binance, take it to Terra Ecosystem, and burn it in exchange for LUNA, which is valued at $1, and sell it for a profit of 0.01$.
But the main question was why people like Tushar will buy UST
They are attracted to the Anchor protocol which offers 20% APY, So big money flows into this protocol and uses this as a high-Interest saving account.
Let’s get back to our main topic: how this LUNA crashed.
If the price of UST drops below $1, users will create Luna tokens by burning UST.
But what if the UST price stays below $1 for a longer period People will create more LUNA tokens, increasing the supply of LUNA exponentially and lowering the price of LUNA.
i.e. If LUNA price goes down = More LUNA Mint = Luna Price Low = More Luna minting = impossible to stabilize UST
Boom!!!!! market crash………………!
What hackers simply need to do was put the UST price Less than a dollar for a long period
Price Chart of UST from 8th May hacker keeps UST price below 1$
how do they do it?
So, what the attackers did they were draining liquidity from UST which was worth approximately
250 million dollars.
After Draining 250 Million dollars of UST the attackers began to unlimited sell of UST on Binance and tried to keep the price below 1$ for a longer period
That’s it domino effect played our and more mint of LUNA happen to peg the UST at 1$ but LUNA was Losing its value
- In a single day, It lost Nearly 50% of its value.
- After this people panic and huge selling happen.
Boom game over and Luna Hackers to zero.
Hackers shorted all the crypto assets and LUNA before this attracted rob all of the money and made a huge profit from all the tokens.
Let’s end this article with a meme!
Stay tuned for more such amazing articles.