The Terra foundation had a successful launch of its stabelcoin UST. However, when the crypto market started to crash, Terra entered hot waters as UST loses its peg and slips to a current price of $0.88. What is UST crypto and why did it lose its peg? Was it a staged attack or UST couldn’t handle the crypto crash? Let’s clarify everything about UST crypto!
What are Stablecoins?
Before we start talking about UST and the events involving this project, we need to understand its nature first. Stablecoins are digital currencies. Their price is tied 1 to 1 to another financial asset. The most popular of these coins are pegged to the US dollar. This gives investors in crypto assets the opportunity to convert their money into a more useful form in a market that is highly volatile. Before their introduction, converting FIAT money into cryptocurrencies was much more difficult.
There are currently 3 different types of stablecoins:
- Stablecoins with Collateral: With this type of stablecoin, each individual coin is backed by an asset. For example, a financial organization can hold a US dollar equivalent for each coin (Example: Tether USDT, USD Coin USDC, Binance USD BUSD).
- Algorithmic stablecoins: These coins use certain blockchain-based mechanisms to keep the price of the coins constant (example: TerraUSD UST).
- Collateralized stablecoins: This uses smart contracts to tie up other crypto assets as collateral for loans. From these loans, programs generate new coins (example: Dai).
What is UST token?
UST is an algorithmic stablecoin developed by the Terra Foundation. In theory, it acts as a cryptocurrency with a “stable” price. Crypto traders can in turn swap to it when the crypto market is volatile in order to hedge heavy price fluctuations.
In order to keep its peg, UST does not have an actual “cash reserve” like other stablecoins. Instead, it destroys or creates LUNA tokens. It basically works as an arbitrage system, inviting arbitrageurs to “buy the dip” and “sell the top” instantly thanks to liquidity pools. This in turn keeps its price pegged to 1$.
Why did UST crash below 1$?
The algorithmic stablecoin UST consists of a basket of several cryptocurrencies. The arbitrage activity that keeps UST pegged is successful under normal market conditions. During the current crypto market crash, one-sided buys or sells can’t keep the equilibrium, thus breaking the peg. This requires heavy intervention, like excessive buying or selling depending on which side was broken. In today’s case, Terra foundation needs to buy excessively to bring the peg back to 1$.
Will Bitcoin crash because of UST?
Since the founder of Terra said that there will be a direct intervention from the buying side, Bitcoin’s price will heavily be influenced. The Luna Foundation Guard (LFG) stated that it will “lend” around $1 Billion worth of Bitcoins to trading firms in order to gain liquidity, buyback at higher prices, and keep the peg.
This is all great, but what if Bitcoin prices fall further? UST’s peg will be smashed. Also, trading firms are heavily involved in short-selling activities. This also increases the selling pressure on Bitcoin and other cryptocurrencies. That’s why analysts fear the next coming days and weeks as they will be bloody for the crypto market.
Will UST Recover?
A big part of recovery is played out by the entire sentiment of the cryptocurrency market as a whole. Currently, there is panic and FUD. Snowball effects often play out, causing a further unnecessary drop in prices. Should the market recover, Terra will be able to counter the drop in UST’s peg thanks to its higher-valued basket of cryptos. On another side, when they get back their loan, it’ll also be valued higher. We remain on the lookout for what happens next with UST, Bitcoin, and the crypto market in general!