Terra Luna went into the headlines in the world of crypto for not the right reasons at all. Recently, the coin dropped about 3/4th of its net worth, from a respectable $32.53 to about $4. But why has this happened?
For that, we need to understand UST (Terra USD). Terra USD is an algorithmic stablecoin which is the main reason for the success of the Terra ecosystem. In simpler words, LUNA and UST have a very strong link. LUNA invests in UST and with time as UST demand increases, LUNA loses money.
However, another significant event happened in the lifecycle of LUNA: Columbus-5. Columbus-5 aims at simplifying the economic design of Terra and improving the value capture of LUNA holders. All of this is based on UST’s growth. To do so, the ecosystem had to decrease the liquid supply of LUNA. For that, they increased burning and staking of UST alongside expanding its cross-chain governance.
All in all, by making the value of UST volatile, LUNA’s value could fall which is exactly what happened. Also, the recent devaluation of the US dollar played a spoilsport to LUNA. Finally, when the UST Curve pool began shrinking, users exchanged it for competing stablecoins. This led to UST trading below its dollar peg. LUNA had to pay the price of the short-sell of UST. In order to curb this, Terra had to push a lot more LUNA into the market further pushing its price down.
In a nutshell, the price crash of LUNA exposed the risks of algorithmic stablecoins. Due to macro-market volatility, UST fell down significantly which sparked a major sell-off in LUNA. So, investors must proceed with caution whenever investing in algorithmic stablecoins.