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CRYPTOCURRENCY

Cryptocurrency prices: what is the correlation between UST and Luna that explains its big drop?

One of the largest cryptocurrencies lost nearly all of its value overnight. How can it be explained?

Update:
The collapse of the Terra ecosystem, and the tokens Luna and UST, will go down as one of the most painful and devastating chapters in crypto history.
BloombergGetty

Before May 10, TerraUSD was in the top 10 most valuable cryptocurrencies with an estimated market value of more than $40 billion. However, a huge market crash sent the value tumbling (understatement) to $500 million, a drop of nearly 99 percent.

What is UST?

UST is another name for TerraUSD, a cryptocurrency stablecoin. These coins are usually pegged, either literally or artificially, to the United States Dollar. These coins are important for decentralised finance as they are a way to try and stop some of the worst volatility in the crypto market.

A difference with TerraUSD to other stable coints is that it us not backed by actual US dollars. Its sister coin is Luna, a normal cryptocurrency. Both are maintained by Terraform Labs. To get a coin of one, the other has to be burned. Alternatively, selling one is supposed to cost the same as the other. This is supposed to keep the market pegged to the dollar as people can make money by selling one of the coins while the other is underperforming, keeping the coins decentralised but in theory having a tight link to real world value.

Why did both drop in value so much?

The Anchor lending protocol was home of around 75 percent of UST’s circulating supply. What this did was promise 20 percent yields to those who invested in it, basically a crypto loan with high interest. But these returns can only go on for so long. This was realised, and investors began to sell up, upsetting the balance between UST and Luna..

The slide was so great that those who invested in Luna, the linked-coin, to try and right the market again were either too late or unwilling. Their joined value fell further.

The losing of the dollar peg was crucial. If UST slips to 99 cents, traders could profit by buying an amount of UST and exchanging it for luna, profiting 1 cent per token. Losing a peg is usually not terminal, but it was for UST. Once trust that it could reach $1 value was gone, everyone sold up.

Faith had been permanently lost in UST and Luna would pay the price. It’s value collapsed from $85 to $0.04 in the space of a few days. As of publication, the coin is worth less than a penny. Over $15 billion in crypto value was lost by the collape of Luna and UST. It is no longer possible to trade on terra’s blockchain, making transactions impossible.

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