Terra Death Spiral Hits $3 as Bailout Rumors Fade

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Terra has continued to collapse as the blockchain’s UST stablecoin has failed to regain its dollar peg. Rumors that a venture capital-backed bailout has fallen through have added increased downward pressure on LUNA’s price. 

Terra Downfall Continues 

The Terra ecosystem is falling apart. 

The Layer 1 blockchain’s LUNA token has fallen an additional 90% in the last 24 hours as selling pressure reached unprecedented levels. Terra’s algorithmic UST stablecoin has also drifted further from its dollar peg, briefly sweeping lows of $0.30 before posting a slight recovery. LUNA is currently trading just above $3, down over 96% this week alone. 

Efforts to restore UST’s dollar peg have severely impacted LUNA’s price. UST aims to keep its peg algorithmically by letting anyone swap 1 UST for $1 worth of LUNA tokens. Normally, this algorithmic relationship would incentivize arbitrageurs to extract value from the difference in price between UST and U.S. dollars, helping it hold a price of around $1.  

Terra’s dual token mechanism usually keeps UST within 1% of its expected dollar value. However, when UST falls significantly below its dollar peg, the algorithmic relationship produces more LUNA tokens that arbitrageurs need to sell on the open market to profit from their trades. If UST’s peg is not restored, the influx of LUNA tokens can create a death spiral that continually drives its price lower until UST’s peg is restored. 

In response to LUNA’s steep decline, Terraform Labs CEO Do Kwon took to Twitter Wednesday to address the community and outline the company’s next move. “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,” Kwon stated, referring to the imbalance between the circulating supply of UST and the diminished market cap of LUNA. To help speed up the process of reducing the UST supply below the market cap of LUNA, Kwon has endorsed a new community proposal that will increase UST burning and LUNA minting capacity from the current rate of $293 million to $1.2 billion.

LUNA is not the only Terra ecosystem token to suffer extreme losses over the past 24 hours. The tokens of top Terra DeFi protocols such as Anchor and Astroport have also respectively plummeted by 72.3% and 81.6%. According to blockchain data platform DeFi Llama, the total value locked in Terra DeFi protocols has dropped more than 87% from $29.65 billion on May 5 to $3.75 billion today. 

Yesterday, Terra’s LUNA token appeared to have stabilized around $30 as rumors of a bailout circulated on social media. According to Larry Cermak, Vice President of Research at The Block, several venture capital firms, including Jump Capital and Alameda Research, were rumored to provide $2 billion to “bail out” UST and help it regain its dollar peg. 

However, a more recent Twitter post from crypto researcher mhonkasalo indicates that the fundraising may have fallen apart. Whether this rumor is true is not yet confirmed. Still, in light of LUNA’s continued breakdown and confidence in UST waning, it seems likely that previous backers are getting cold feet when asked to invest even more money to help prop up the Terra ecosystem.  

Disclosure: At the time of writing this piece, the author owned ETH, LUNA, and several other cryptocurrencies. 

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