Stablecoin 'Terra' Collapses In 'Digital Bank Run', Founder Outlines Path Forward

Following a brief respite, panic appeared to set in overnight as ‘Stablecoin’ Terra failed to steady its bleeding crypto assets.

After attempts to shore up the peg when both LUNA and Bitcoin reserves failed, another mass sell-off, which some argued was “coordinated” to destroy the Terra ecosystem, sent the stablecoin crashing to 30c as traders warned of a “death spiral” in an asset that should supposedly be pegged to the dollar.

Holders of TerraUSD, or UST, and sister cryptocurrency luna were left anxiously waiting for details of a rescue plan, which founder Do Kwon said on Tuesday was coming soon.

Getting close … stay strong, lunatics

— Do Kwon 🌕 (@stablekwon) May 10, 2022

Rumors circulating online suggested that other major crypto firms may be willing to contribute funds to support the peg, but Luna continued to slide…

After leaving traders hanging overnight, Do Kwon, the founder and CEO of Terraform Labs, broke his Twitter silence to reveal the Terra network’s next steps in the wake of this week’s crash.

Kwon’s primary objective at the moment appears to be to bring the stablecoin back to $1. To re-peg UST, Kwon has proposed an increase the supply of LUNA on the market in order to absorb investors’ attempts to offload the broken stablecoin.

Here is the full thread:

Dear Terra Community:

I understand the last 72 hours have been extremely tough on all of you – know that I am resolved to work with every one of you to weather this crisis, and we will build our way out of this.

Together.

First, if you don’t understand how Terra’s peg stabilization mechanism works, here is a good overview:

Update on Luna Tokenomics
+
How to predict when depeg will end.

Bringing back my “death spiraling Luna” model. Turns out it was accurate. All of those “Didn’t age well” jabs at it Didn’t Age Well.

1/24
🧵

— Pedro Ojeda (@pedroexplore1) May 11, 2022

A review of the current situation: UST is currently trading at 50 cents, a significant deviation from its intended peg at $1.

The price stabilization mechanism is absorbing UST supply (over 10% of total supply), but the cost of absorbing so much stablecoins at the same time has stretched out the on-chain swap spread to 40%, and Luna price has diminished dramatically absorbing the arbs.

Before anything else, the only path forward will be to absorb the stablecoin supply that wants to exit before $UST can start to repeg. There is no way around it.

We propose several remedial measures to aid the peg mechanism to absorb supply:

First, we endorse the community proposal 1164 to Increase basepool from 50M to 100M SDR *) Decrease PoolRecoveryBlock from 36 to 18.

This will increase minting capacity from $293M to ~$1200M. station.terra.money/proposal/1164

This should allow the system to absorb the UST more quickly. https://station.terra.money/proposal/1164

More ideas will be discussed in the community forums at Terra Research Forum: A place dedicated to quality discussions around the Terra Protocolhttp://agora.terra.money

With the current on-chain spread, peg pressure, and UST burn rate, the supply overhang of UST (i.e., bad debt) should continue to decrease until parity is reached and spreads begin healing.

Naturally, this is at a high cost to UST and LUNA holders, but we will continue to explore various options to bring in more exogenous capital to the ecosystem & reduce supply overhang on UST.

As we begin to rebuild UST, we will adjust its mechanism to be collateralized.

The Terra ecosystem is one of the most vibrant in the crypto industry, with hundreds of passionate teams building category defining applications within. As long as these builders, TFL among them, continue to build – we will come out of this together.

Terra’s focus has always oriented itself around a long-term time horizon, and another setback this May, similar to last year, will not deter the #LUNAtics. Short-term stumbles do not define what you can accomplish.

It’s how you respond that matters.

Terra’s return to form will be a sight to behold.

We’re here to stay. And we’re gonna keep making noise.

The good news for now for the rest of the crypto universe is that the crisis in Terra is not slopping over into Bitcoin this time…

Perhaps the stability in BTC and ETH is due to Kwon’s shift to ‘collateral’-backing (rather than algorithmic) – like other decentralized, collateralized, stablecoins like MakerDAO‘s DAI – which is backed by a combination of cryptocurrencies like Ethereum, USDC, Wrapped Bitcoin (WBTC), and other assets.

It remains to be seen, however, how such a collateralized mechanism would work for UST.

Ilan Solot, partner at crypto group Tagus Capital, told The FT that “the gut reaction is to cast the [TerraUSD] debacle as bad news from a regulatory standpoint — and it might turn out to be”. However, he said that it could also highlight the differences between algorithmic coins and those backed by a basket of reserves.

In a research note on Wednesday, UBS said the TerraUSD episode “will also likely heighten regulators’ focus on USDC and Tether, which, though not yet systemically important to the broader financial payments, clearing and settlement, are linchpins of the crypto trading industry”.