A series of stable digital currencies (stablecoins) are under scrutiny after regulators and investors witnessed UST plummet from a fixed level of one USD to just 0.03 USD on May 13.
LUNA cryptocurrency decreased in value after a short period of time.
The collapse of UST and Luna caused investors to lose billions of dollars, while also affecting a series of other cryptocurrencies.
What are stablecoins?
Cryptocurrencies like Bitcoin are unstable digital assets, prone to unusual fluctuations in a very short period of time just because of a tweet from Tesla CEO Elon Musk.
Stablecoins are designed to minimize that risk.
Stablecoins have become important to the cryptocurrency ecosystem over the past two years, with traders and investors accumulating about $180 billion in stablecoins as of mid-May.
How does the UST stablecoin work?
Currently, there are two main stablecoins.
The second type builds a `decentralized` algorithm, typically TerraUSD (UST).
Luna is the project governance token of the Terra blockchain, playing an important role for UST and the stablecoins in this network.
When the price of UST is low, players will buy and exchange it for Luna to make a profit.
Luna has a close connection to UST.
Terra was created by Terraform in 2018 with two founders, Do Kwon and Daniel Shim.
The reason why Luna lost its value
The catalyst leading to the decline was a series of large withdrawals from Anchor Protocol, a type of digital currency bank established by Terraform.
As of early May, investors had poured Luna money equivalent to more than 14 billion USD into Anchor.
The large amount of transactions on Anchor causes the balance algorithm between UST and Luna to fluctuate strongly, causing a de-peg situation for UST.
When UST is de-peg, players still convert UST to Luna according to the correct balance algorithm to reduce supply.
The instability created a rotation reaction, causing more and more investors to withdraw UST from Anchor to sell.
Impact on other cryptocurrencies
Developer Do Kwon once founded the non-profit Luna Foundation Guard (LFG) with capital reserves in Bitcoin and many cryptocurrencies with a total value of three billion USD.
What happens next?
Do Kwon is trying to rally support from the community after the UST and Luna sell-off, but many have sold out of both, believing they will not recover to their original value.
The collapse of Luna and UST also caught the attention of US lawmakers, revolving around the lack of regulation governing stablecoins and the cryptocurrency market in general.