The UST Bank Run and How it Happened

May 10, 2022

Cryptocurrencies: Weekly Update

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blankThe UST stablecoin which is supposed to be fixed to the price of $1 USD sold off to as low as $0.60 on Monday. The de-pegging of UST from the USD caused a bank run on the stablecoin, and forced a -53% selloff in the LUNA token on Monday as investors desperately tried to sell their UST holdings back into cash or other safer stablecoins.

Stablecoins are cryptocurrencies that have a value that is fixed to another asset, most typically being pegged to fiat currencies like the US Dollar.

Rather than serving as investment vehicles, stablecoins primarily exist for the purpose of digital trading, saving, and transacting. However, there are plenty of lucrative opportunities out there to yield interest on your stablecoins by offering them to an exchange or market maker as liquidity, allowing you to earn by lending.

You’re unlikely to spend BTC or ETH on a daily basis due to their constant volatility and price fluctuations, so you can use stablecoins instead as a fixed value cryptocurrency.

One would think that for a stablecoin to maintain a consistent peg to the price of the US Dollar, the creator of that stablecoin would hypothetically need to have $1 USD in reserves for each stablecoin that is issued in order to prevent a bank run from occurring. Unfortunately, this isn’t how most stablecoins actually work.

Thanks to the unique algorithmically-backed nature of Terra’s UST stablecoin, it was left susceptible for attacks and bank runs.


The Luna Foundation Guard (LFG) is composed of founders of Terraform Labs (LUNA) and serves as the non-profit body that is responsible for maintaining the stability of the UST stablecoin.

LFG and Terraform Labs set out to create the UST stablecoin so that it would function differently from rival stablecoin Tether (USDT) and not require actual dollar reserves held by a centralized bank. Tether is owned and operated by Bitfinex and is thus inherently centralized as the Bitfinex team has the hypothetical ability to manipulate or change the USDT that is in circulation.

In order to create UST without centralizing the stablecoin’s reserves, the Terraform team designed it as an algorithmic stablecoin, meaning that there are automated minting and burning mechanisms that are supposed to ensure price stability to the US Dollar peg. LUNA is a reserve asset that supports UST, meaning that you should always be able to exchange 1 UST for $1 of LUNA and vice versa. To mint or create one token, you must burn equivalent value in the other token. By design, market arbitrageurs will help sustain the stable price of UST by buying or sell the float based on fluctuating demand on the open market.

In recent months, LFG has repeatedly made headlines for their ongoing acquisition of several billions of dollars worth of Bitcoin to be used as additional reserves for their stablecoin. The purpose of buying Bitcoin and other altcoins like Avalanche (AVAX) was to ensure that LFG had cash/crypto on hand to balance the scales in the event of rapidly decreased market demand for UST… and that is exactly what happened this past weekend.

UST first began trading for a slight discount on Saturday when billions of dollars worth of UST was pulled from liquidity pools and lending protocols (Anchor) and dumped onto the open market. This became the catalyst for market makers to evacuate from their UST positions en masse on Monday, forcing the stablecoin’s price to go into freefall.

LFG was forced to deploy $1.5 billion worth of Bitcoin and UST as loans to OTC trading firms as an attempt to re-stabalize the UST’s peg. $750 million of BTC for the purpose of buying UST, and $750 million UST for buying BTC as markets stabilize.

Thanks to a combination of abysmal demand and liquidity rapidly being pulled out by institutional counterparties, UST tumbled to as low as $0.62 and is only back to $0.901 as of the time of writing.


Who is Responsible for Dumping UST?

Since Saturday, cryptocurrency analysts have been noticing rather unusual and outsized activity from crypto whales. On-chain analysts have investigated some of the wallets that were responsible for dumping massive amounts of UST and causing the bank run and determined that those same wallets were opening short positions in LUNA. Some whales even bought back UST at its absolute lows right before it turned around and headed back towards $0.90.

Essentially, everyone believes that this was a coordinated attack against the UST stablecoin but the question is by who? And was the perpetrator aiming to simply point out an inherent flaw in UST’s design so that it can address potential liquidity concerns and fix them moving forward, or was this a malicious attack and attempt to take the entire project offline permanently?

Right now, analysts are primarily pointing their finger to Citadel and Ken Griffen, with this popular thread circulating in online forums:

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The message above mentions ‘Kwon’ which is short for Do Kwon, the founder of Terra. Not all too surprising if true, as Citadel has been known to be a bit of a bully in the crypto space before. Taking advantage of a new and somewhat theoretical system of creating a stablecoin presents the opportunity to make a ton of money for those who have the deep market knowledge to exploit something like UST.

Citadel is the type of firm that has the experience, money, and ability to do exactly what is being described above. 


How Did this Impact Bitcoin?

Many are calling this a stress test on the relatively new stablecoin, especially because other stablecoins such as USDT have been temporarily depegged in the past but managed to re-peg and survive. However, LFG likely took significant losses on their BTC reserve positions that were liquidated yesterday just to keep UST alive.

This entire ordeal turned the market’s recent largest BTC buyer into a seller on Monday, providing plenty of downward pressure along with the already gruesome day for equity markets that was already beating up the crypto market on Monday morning.

However, all of this bad news and Bitcoin still didn’t close below the psychological $30,000 level. For now, holding above $30k is essential for BTC, but a further selloff down to $28,800 is still very much on the table.

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In the unlikely event of a major recovery bounce from here, we’d want to re-establish support on a closing basis above $33,000. Both RealMotion indicators are sufficiently oversold on a daily basis, but are making lower lows which indicates a potential breakdown on a long-term basis.

Zooming out to a weekly timeframe shows us that BTC is still in a warning phase and well above its 200-week moving average. While price may be at oversold levels, momentum is not yet oversold according to both the short and long term RealMotion indicators, telling us that there very likely be enough appetite to force prices down below $30,000.

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Tuesday’s market has shown a rather lackluster bounce for both the stock market and cryptocurrencies, indicating the likelihood of further selling throughout the week.

Anticipation for more rate hikes from the Fed, the Russia-Ukraine conflict heating back up and global supply chain issues is providing a bleak outlook for all equity markets at least for the foreseeable future. Don’t count on crypto to turn around all at once, now is when we’ll likely see long-term consolidation around $30,000.


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