The first week of May was a devastating one for the crypto space because one of the top ten coins in the market collapsed. The UST algorithmic stablecoin was de-pegged and this saw the TerraUSD implode. Before the crash occurred, the Luna Foundation Guard (LFG) had announced that they were purchasing Bitcoin for backing the value of the stablecoin.
Once the crash occurred, LFG announced that it was trying to maintain the peg and so it sold the purchased bitcoin. Therefore, the crypto community concluded that it was the Terra crash that saw Bitcoin plummet as well, bringing it down to its lows of December 2020.
UST Not Responsible for Bitcoin Crash
A report was recently published by renowned blockchain analytics company, Chainalysis, about the crash of the TerraUSD (UST) coin. According to the report, the implosion of the stablecoin and its sister crypto, Luna, had undoubtedly dented the crypto market, but it was not responsible for the overall decline that happened.
The report stated that the crypto downturn was not because of the collapse of Terra, but more because of the decline in the tech market. In the previous year, as institutional adoption of bitcoin has gone up, analysts have talked about the correlation that has developed between the stock market and bitcoin’s price.
As per Chainalysis, the correlation between tech stocks and Bitcoin was ‘relatively new’. It appears that the world’s largest cryptocurrency has developed a major correlation with stock indices, such as the S&P 500 index and the Nasdaq 100 Technology Index.
Bitcoin’s price had dipped when the UST crashed, but that did not last for long. The price of Bitcoin was able to make a recovery after the coin’s collapse and was once again responding to the tech stocks. But, one effect the crash did have was on the stablecoin redemptions, which saw a massive increase. According to exchange data, stablecoin trading volumes had recorded a major rise between May 9th and May 12th.
This was primarily because the UST collapse had lots of investors losing their confidence in stable coins because an asset that had previously been considered non-volatile and safe had suffered losses in the double-digits within hours.
How The De-Pegging Started
On May 7th, around $150 million was withdrawn by Terraform Labs from 3Pool, Curve’s liquidity pool. Within two hours of this transaction, two individuals exchanged UST worth $185 million with USDC and Curve’s liquidity took a hit. In order to balance this, Terra chose to withdraw an additional UST worth $100 million.
This prompted the stablecoin to deviate from its peg, spooking investors and driving them into dumping the coin on exchanges. The peg continued to slide, prompting LFG to sell Bitcoins worth a billion to save it, but there was no impact. A mint-and-burn mechanism was used for maintaining UST’s peg, since it was an algorithmic stablecoin. This existed between UST and the LUNA token. The demand for the latter went up due to hyperinflation and this caused it to crash as well.