The LUNA Death Spiral: What Happened to the Stablecoin in 2023?

Even as the entire cryptocurrency market collapsed, the news that Player.me made headlines was the combined implosion of Terra’s UST and LUNA.

The sharp decline in the prices of these two currencies was labeled the LUNA death spiral by industry experts, despite the incident’s name focusing only on one coin. It is important to bear in mind that the fates of these two assets were intertwined.

What Is UST and LUNA?

Let’s first discuss the differences between UST and LUNA. Both tokens originated from the Terra blockchain network. LUNA is a cryptocurrency asset and also a governance token designed to maintain the stability of UST’s price.

LUNA had no maximum supply quantity because its supply was directly linked to the number of Terra stablecoins in circulation. However, the supply of LUNA would decrease over time as it was regularly burnt or converted into Terra stablecoins. This mechanism helped maintain the stability and peg of UST to its target value.

What Is It About the USDT and USDC?

Indeed, the burn mechanism of LUNA was designed to create a potential for the price of LUNA to increase over time. As for UST, it functioned as an algorithmic stablecoin and differed from other stablecoins like USDT and USDC.

Unlike those stablecoins, UST wasn’t backed by the U.S. dollar or other fiat currencies. Instead, it utilised LUNA to maintain its price stability at $1. This was achieved by burning LUNA tokens in order to generate new UST tokens whenever the price of UST deviated from its target value of $1.

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Users had the ability to exchange LUNA for UST and vice versa within the Terra ecosystem at a guaranteed one-to-one price, regardless of the current market price of either token. For instance, if the demand for UST increased and its price exceeded $1, LUNA holders could profit by trading $1 worth of LUNA for one UST, which would be valued higher than $1 due to the surge in demand.

During this exchange process, a portion of the LUNA would be burned or taken out of circulation, while the remaining amount would be placed into a treasury that invested in applications and services to enhance the utility of the Terra ecosystem.

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LUNA Death Spiral

Burning a portion of LUNA’s total supply reduced the overall number of circulating tokens, making them scarcer and more valuable. On the other hand, creating more UST could dilute the tokens already in circulation, bringing the overall price back down to its intended $1 level.

Similarly, if the demand for UST was low and its price dipped below $1, UST holders could exchange 1 UST for $1 worth of LUNA, thereby reducing the supply of UST. This exchange would allow them to profit from the transaction, as they could use less than $1 to acquire $1 worth of LUNA.

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How Experts Talk About the APY Users of UST?

According to “CoinDesk“, the demand for LUNA significantly diminished primarily due to the situation with Anchor, a lending and borrowing protocol. A majority of the demand for UST, around 70%, stemmed from Anchor, as it offered a high annual percentage yield (APY) of approximately 20% for users depositing their UST.

However, many experts argued that such high APY rates were not sustainable. When Terra was unable to maintain the promised yield and proposed to decrease the rates, UST holders began selling their tokens. Since a significant portion of UST holders were involved with Anchor, this massive sell-off caused UST to lose its peg to the U.S. dollar, resulting in a crash. Consequently, the loss of the U.S. dollar peg triggered a large-scale selling of LUNA, leading to a decline in its price.

As panic selling intensified, UST’s price stumbled to an all-time low. To summarise, UST was backed by LUNA, so when UST’s price dropped, UST holders started burning UST in exchange for LUNA, thereby increasing the supply of LUNA. The increased supply of LUNA led to a further decrease in its price. This cycle continued, exacerbating the crisis. Did you anticipate this unfolding situation?

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Frequently Asked Questions

What Causes the LUNA Death Spiral?

The LUNA Death Spiral is typically caused by a combination of factors, including gravitational perturbations from the sun, irregularities in the moon’s gravitational field, and the presence of other gravitational influences such as nearby celestial bodies.

How Does the LUNA Death Spiral Affect Satellites?

Satellites caught in the LUNA Death Spiral will experience a gradual decrease in altitude and an increase in orbital eccentricity over time. Eventually, they will be pulled closer to the moon’s surface, ultimately resulting in a collision and destruction.

Are There Any Satellites Currently Experiencing the LUNA Death Spiral?

As of my knowledge cutoff in September 2021, there have been no confirmed reports of satellites experiencing the LUNA Death Spiral. However, it is a theoretical phenomenon that could occur under certain circumstances.