Luna reached an an all time high of $116 last month. Today it is worth $0.00512478. Once a top 10 most valuable crypto coin, Luna shut down its network today effectively ending the project.
The coin lost 98% of its value in a span of 24 hours. During this timeframe the crypto market saw a loss of $40 billion dollars. If you had invested $10,000 in Luna 7 days ago, at the time of publishing your holdings would be worth $0.62. How did this happen? What went wrong?
What is LUNA and TERRA (UST)?
Founded by Do Kwon, a former Stanford University computer science grad who appeared on CoinDesk’s most influential 2021 list, the Terra ecosystem has experienced tremendous growth recently. The market capitalization of UST grew from $180 million at the start of 2021 to almost $15 billion in March 2022, while LUNA’s price soared by 138-fold.
Luna (LUNA) and Terra (UST) are two native tokens of the Terra network, a blockchain-based project developed by Terra Labs in South Korea. Terra is known as an algorithmic stablecoin.
The price of the LUNA token has experienced an astronomical rise in price over the last year. In 2021, LUNA traded at $0.66 and closed the year at $89. Subsequently, it hit its all-time high of $104.58 on March 9, 2022, at a time when most other cryptocurrencies were falling in tandem with global capital markets catalyzed by the Ukrainian invasion crisis.
From relative obscurity, UST has emerged to become the fourth-largest stablecoin behind tether (USDT), USD coin (USDC) and Binance USD (BUSD), surpassing $15 billion in market capitalization.
How Were They Valued?
According to Terra’s white paper, the founders’ goal was to fulfill what Bitcoin originally set out to be: a peer-to-peer electronic cash system. To achieve that, Terra deploys a system of stablecoins – cryptocurrencies whose value is pegged to different assets such as commodities or fiat currencies.
Luna's value is tied to the Terra stablecoin. Terra, in turn, is supposed to be tied to the United States dollar. A mechanism was supposed to work so that people could trade one for the other if one of the two went under that price.
If Terra traded for less than $1, people could exchange it for $1 worth of Luna. If Terra traded for more than $1, people could buy $1 of Luna and then exchange it for more than a dollar of Terra.
How Does an Algorithmic Stablecoin Work?
Stablecoins are a specific type of cryptocurrency whose price is pegged, usually to a state-issued fiat currency such as the U.S. dollar. What makes stablecoins in the Terra blockchain different is the method they use to keep the price stable.
Instead of relying on a reserve of assets to maintain their peg, as USDC and USDT do, UST is an algorithmically stabilized coin. This involves using a smart contract-based algorithm to keep the price of TerraUSD (UST) anchored to $1 by burning (permanently destroying) LUNA tokens in order to mint (create) new UST tokens.
How Was Luna Attacked?
To make it very clear Luna was attacked which caused its downfall. It was a clearly planned and well executed attack. Here is how the Luna attack was carried out.
The attacker accumulated $1 Billion of UST which is another stablecoin. Using that they borrowed $3 Billion in Bitcoin (BTC). Now well armed with ammunition to take down UST the attacker waited for the correct moment to pounce.
The Luna Foundation Guard (LFG) had signaled their intent to pull some liquidity from from their 3-pool to shift it to the new 4-pool. LFG removed $150 Million UST from the 3-pool on Curve in preparation for the move to the 4-pool.
At this moment the attacker uses $350 Million of their UST to drain the Curve pool. This results in no liquidity on Curve. The price of UST starts to depeg from $1 and drops down to a $0.97 value.
With the value dropping, people who had LUNA deposited on Anchor for the 20% yield, started to pull their deposits out.
At the start of the attack Anchor deposits were $14 Billion. As panic started to spread the value of deposits being removed from Anchor reached $10 Million per minute.
The attacker starts selling their remaining $650 Million UST on Binance. This leads to a bigger depeg of the price of UST which drops lower and lower.
LFG steps in and starts selling their Bitcoin to buy UST to try to restore the peg to $1.
This downward pressure on the price of UST results in a death spiral that dramatically lowers the price of LUNA. Traders start to short LUNA which leads to even more of a downward spiral in price.
Eventually LFG realizes their plan of selling Bitcoin to buy UST to restore the peg is like trying to bail out the sinking Titanic with a small bucket. They give up and the price of UST and LUNA continue their downward spiral. In 24 hours $40 billion of value in LUNA dissipates from the crypto market.
As the price of UST falls below $0.50, LFG realizes that they are at a point of potentially facing a governance attack and they decide to shut down the LUNA network.
It took less than 4 days for LUNA to go from a crypto darling to crypto dead.