On May 9, 2022 the crypto world was rocked by the sudden collapse of Terra (LUNA) and TerraUSD (UST). This was followed by a major sell-off of other cryptocurrencies, leading to widespread panic among investors.
Amid the chaos that saw LUNA drop over 99% from its May 6, $80 print- and UST lose its peg, TerraLabs founder and CEO Do Kwon stepped forward with a recovery plan that will hopefully stabilize and promote a LUNA recovery.
Kwon took to Twitter to share details of his plan which includes the introduction of a mechanism for collateralized UST.
Stablecoins like Tether (USDT) and Circle’s USD Coin (USDC) are collateral-backed digital tokens whose value is pegged to the US dollar. This form of cryptocurrency is unlike algorithmic stablecoins that are dependent on the value of the underlying asset and instead use smart contracts to maintain price equilibrium. In other words, each USDT or USDC traded in the market is backed by what’s actually in the possession of the stablecoin issuers.
Kwon’s mechanism involves burning and minting UST/LUNA to retain price stability. The mechanism is designed so that when the price of UST falls, the system automatically burns UST/LUNA. When the price of UST rises, the system mints new UST/LUNA. As mentioned, the purpose of the system is to keep the price of UST stable.
The mechanism is also designed to be self-regulating given the supply of UST/LUNA is constantly being adjusted to meet the demand. When there is more demand for UST/LUNA, the system mints new UST/LUNA. When there is less demand, the system burns UST/LUNA.
The mechanism is also transparent since all transactions are recorded on the blockchain. Anyone can see how much UST/LUNA is being burned or minted.
Kwon also explained in his Twitter thread why LUNA and UST nosedived, saying that 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.”
5/ 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.
— Do Kwon 🌕 (@stablekwon) May 11, 2022
According to Kwon, the recovery process has to start with the absorption of “the stablecoin supply that wants to exit before $UST can start to repeg.”
Meanwhile, Kwon’s proposal to increase the base pool from 50M to 100M and decrease PoolBlockRecovery from 36 to 18 is a smart move that will help absorb the UST in circulation and help it rebound to its earlier dollar peg. By accelerating the minting capacity from $293m to $1.2bn, Kwon is giving UST the chance it needs to get back on track.
7/ 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. https://t.co/aqNKzYK2xC
This should allow the system to absorb the UST more quickly.
— Do Kwon 🌕 (@stablekwon) May 11, 2022
Kwon also said that the aim here is to make UST a more robust and resistant to extreme market turbulence. In order to achieve this, Terra will be introducing mechanisms to make the stablecoin more collateralized. This will help to stabilize the UST ecosystem and make it more resilient to shocks.
In addition, by making UST more collateralized, Terra will be able to provide greater security to users and attract more users to the platform. Ultimately, the hope is that this will help to further increase the stability of the UST ecosystem.
However, Kwon noted that this would not be without having an impact on the UST/LUNA hodlers.
“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,” said Kwon.
While it remains to be seen whether Kwon’s plan will be successful, it provides a path forward for those who are looking for a LUNA recovery. Only time will tell if the currency can recover from its recent crash, but Kwon’s proposal offers a glimmer of hope for holders who have seen their investment disappear overnight.
Price Action
LUNA lost 98% during today’s trading and changed hands at $0.03637, accelerating its weekly crash to about 100%.
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