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The first week of May was rough for the cryptocurrency community because it saw the collapse of a cryptocurrency that ranked as a top-ten coin. The Terra crash was triggered by the depegging of the UST algorithmic stablecoin.
Before the collapse, the Luna Foundation Guard (LFG) announced it was buying Bitcoin to back the stablecoin’s value. However, after the crash, the LFG sold the Bitcoin to maintain the peg, and the community attributed this occurrence to the Bitcoin crash below $28K.
UST depeg did not cause the BTC crash
Chainalysis, a blockchain analytics firm, published a report on the crash of the UST. The report noted that while the collapse caused a dent in the cryptocurrency market, it was not the main factor behind the recession.
“The crypto market’s recent downturn appears more closely linked to the tech market decline than to UST’s collapse,” the report read. Over the past year, analysts have spoken of the increased correlation between Bitcoin’s price and the stock market because of institutional adoption.
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The Chainalysis report noted that the correlation between Bitcoin and tech stocks was a “relatively new development.” Bitcoin has maintained a significant correlation with stock indices like the NASDAQ-100 Technology Sector Index and the S&P 500 Index.
The collapse of UST caused a dip in Bitcoin’s prices, but the effects did not last long. The end of Bitcoin’s sharp decline at the time ended coincidentally with the end of UST’s collapse. After Bitcoin overcame the effects of the crash, the price resumed its tandem with tech stocks.
The other effect of the crash is that it increased stablecoin redemptions. Exchange data showed a significant increase in the stablecoin trading volumes between May 9 and May 12. This was caused by investors losing faith in stablecoins because an asset deemed safe and non-volatile had witnessed double-digit losses in hours.
“All kinds of investors should their stablecoins during the crash, from big, institutional players to retail investors,” Chainalysis said.
The collapse of UST & LUNA
The UST depeg started on May 7 as Terraform Labs withdrew $150M from 3pool, a liquidity pool on the Curve protocol. Shortly after the withdrawal, two individuals exchanged $185M worth of UST into USDC within two hours, affecting the liquidity on Curve. Terraform Labs attempted to rebalance the liquidity by withdrawing an additional $100M UST from the pool.
These massive trades made USTV deviate from its peg, and spooked investors started selling the stablecoin on exchanges, making the peg slide further below. On May 9, the LFG sold billions worth of Bitcoin from its reserves to save the peg, to no avail.
UST was an algorithmic stablecoin, and the algorithm that maintained the peg was a mint-and-burn mechanism between UST and LUNA. If UST dropped below $1, new LUNA was minted to burn UST, and if UST went above $1, investors could burn LUNA.
With the recent UST collapse, users rushed to buy UST and burned it for $1 worth of LUNA. More LUNA was minted, causing hyperinflation, and the total LUNA supply soared to past 6 trillion. This triggered LUNA’s collapse to $0.
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