- Terra's luna crypto crashed by 45% on Tuesday, after the network's stablecoin lost its dollar peg again.
- Over the weekend, hefty selling drove TerraUSD below the $1 mark.
- In response, the project's guiding group said it would sell some of its massive bitcoin reserves to prop up the token.
Terra Network's luna token plunged by as much as 61% on Tuesday, after sister stablecoin TerraUSD lost its peg to the dollar for the second time in as many days.
TerraUSD is an algorithmic stablecoin whose value is fixed to $1. Unlike traditional stablecoins that are backed up by fiat currency and hard assets — including government bonds or even gold — UST, as it's known, has its value set by a computer algorithm.
When UST falls below $1, traders can "burn" coins, which removes them from circulation, in exchange for $1 of luna, the network's sister token. This restricts UST's supply, which then raises its value again. If UST rises above $1, traders then sell luna to convert into UST, which pushes its price down.
Over the weekend, hefty selling of UST forced its value below $1, exacerbating the downdraft and prompting developer group Luna Foundation Group (LFG) to step in and pledge to shore up the stablecoin.
But intense volatility across the broader financial markets on Monday, caused by investors fretting about the outlook for surging interest rates and inflation, hit the crypto market. UST decoupled from the dollar again, leaving the luna token in freefall on Tuesday.
Luna was last down 48% at $31.89 in early European trade, having hit an overnight low of $24.14, according to CoinMarketCap. UST, meanwhile, was holding at $0.9196, having plunged to just $0.68 overnight.
"Over the past several days, market volatility across crypto assets has been significant. The market turmoil is also reflected by the past week's uncertain macro conditions across legacy asset classes," LFG tweeted Monday.
"Per the LFG's mandate, the LFG will proactively defend the stability of the $UST peg & broader Terra economy, especially under volatility and the uncertainty of macro conditions in legacy markets," the group said.
LFG said Tuesday it would inject $1 billion worth of bitcoin, together with more funds from other cryptocurrencies, to support UST.
Last week, LFG announced it had bought $1.5 billion worth of bitcoin to add to its reserves. It has said in the past it intends to acquire $10 billion in bitcoin for its reserves.
"For the first time, you're starting to see a pegged currency that is attempting to observe the bitcoin standard," Terra Labs' co-founder and CEO Do Kwon said after LFG's announcement last week.
However, algorithmic stablecoins are controversial even within the crypto community. "It's a lot more dangerous than taking a T-bill and tokenizing it," Charles Cascarilla, chief executive of Paxos, told the Wall Street Journal last month. Paxos issues Binance USD, a stablecoin that's backed by monetary assets.
The Federal Reserve also sounded a note of caution on stablecoins in a report published Monday. It said the risk of sudden redemptions of stablecoins is similar to those of money-market funds.
"These vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins," it said.
As UST began to tumble over the weekend, multiple crypto observers witnessed large withdrawals of the token from Anchor Protocol, which acts like a bank for UST. One big holder dumped $285 million worth of of the token, crypto news site CoinTelegraph reported.
LFG said in a tweet Monday that it would lend bitcoin to trading firms. "Deploying more capital steady lads," Do Kwon tweeted after.
—Do Kwon 🌕 (@stablekwon) May 9, 2022
This in turn has weighed heavily on bitcoin, which has dropped below $30,000 for the first time since last July. It's lost 33% already this year and is more than 60% below its all-time high of $69,000 from last November.