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UST and LUNA in free fall as the entire crypto market watches the capitulation due to a realization of the key risks
5 min read
Updated: May 11, 2022 at 9:46 am
Cover art/illustration via CryptoSlate
The Swiss-based crypto exchange, SwissBorg, has released a report on the risks surrounding Terra’s stablecoin, UST. The token is currently undergoing extreme volatility, trading at just $0.59 at writing. SwissBorg issued a risk warning to users on May 10 and paused withdrawals of UST on the same day, hours before Binance followed suit. The report was completed in April, and almost all of the risks they identified are currently playing out.
Risks of TerraUSD (UST)
Unlike other stablecoins such as USDT or USDC, backed by fiat collateral and other liquid assets, UST is an algorithmically backed token. CryptoSlate has obtained a report from SwissBorg’s DFi team on UST risks. The report explained, “at any time, users on Terra can burn $1 of LUNA to mint 1 UST, or burn 1 UST to redeem $1 worth of LUNA. Therefore, the fate of UST and LUNA are closely linked, and so are the risks involved.” Importantly. It highlighted four key areas of risk;
- A death spiral of UST-TerraLuna
- Anchor Protocol risks
- UST loss of peg
- A structured model for default.
Death spiral of UST-TerraLuna
SwissBorg recounted a potential “death spiral” between TerraLuna and UST which would cause LUNA to crash and further emphasize a bank run on UST. LUNA is currently trading down 90% since May 9, indicating that this scenario is now playing out with UST also down 30%. The report explains the death spiral in detail.
“If LUNA’s price is under pressure, UST holders could be fearing that the UST peg is at risk and decide to redeem their UST positions. In order to do so, UST is burnt and LUNA is minted and sold on the market. This would exacerbate further the decline of LUNA’s price, pushing more UST holders to sell their UST. This vicious cycle is know and ‘bank run’ or ‘death spiral’
Anchor Protocol Risk
Anchor Protocol is the Terra ecosystem platform that offers high interest in UST staking. The platform has offered up to 19% in recent weeks with a peak TVL of around $15 billion. The TVL has plummeted over the past few days, with both deposit and borrow values free falling.
SwissBorg identified the risk here as “if the price of LUNA (and bLUNA) falls, this could trigger a liquidation of the LUNA collateral positions. UST would then be burned back into LUNA, further exacerbating the LUNA price decrease.”
Via reports from users on Twitter, numerous investors have been unable to access their Terra Station wallets due to network congestion leading to liquidations.
An inability to access wallets has caused users to be unable to deposit funds to decrease their LTV, forcing liquidation. This appears to be partly responsible for the steep decline in LUNA’s price over the past week. SwissBorg specifically stated in their report that “any issue with Anchor would likely cause a cascade of UST redemptions with all the consequences previously mentioned.”
UST loss of peg
Swissborg outlined a potential scenario whereby “a death spiral along with a cascade of liquidations in Anchor could cause the market capitalization of LUNA to fall below the market capitalization of the circulating UST.” As seen on the CryptoSlate coin tracker, this has now played out, with LUNA dropping to just $370M in market cap.
SwissBorg identified this situation alone as being highly correlated with a risk of UST de-pegging. The current state of play has this as just one of the factors affecting the Terra ecosystem. The below graph shows an event in May 2021 where the market cap crossed for a brief period and its effect on the UST peg.
Structured model for default
SwissBorg identified the Merton model for assessing the risk of default as applying to an assessment of the risks associated with UST.
“The Merton model uses the Black-Scholes-Merton option pricing methods and is structural because it provides a relationship between the default risk and the asset (capital) structure of the firm.”
The report illustrated how the complex formula used in the Merton model analyses the risk of an asset falling below its liability threshold, as shown below.
Concerning the Terra ecosystem, the report determined the probability of UST losing its peg.
• Asset value A is represented by the market capitalization of LUNA
• Liabilities value L is represented by the market capitalization of UST
• if at a given time horizon T the market cap of Luna is smaller than that of UST, the UST peg is lost
The above data was charted to show the probability of UST losing its peg daily. In May 2021, the risk rose to just under 100% before falling back to 20% in November. The threat had been steadily rising to 60% as of April 2022. At present, UST, trading at $0.59, has definitively lost its peg.
SwissBorg concluded that “the fate (and risks) of UST are strictly linked to that of LUNA. Any convergence in the market capitalization of LUNA toward that of UST poses serious risks of losing the peg.” Their recommendation was to monitor the position of UST with LUNA closely, watch the TVL of Anchor Protocol for a decline, track market volumes for LUNA to ensure liquidity, and monitor for a decrease in demand for Terra stablecoins.
At present, all of these conditions are true. LUNA has dropped 90%, UST is down 30%, Anchor Protocol TVL is down 60%, and demand for Terra stablecoins is flatlining. Further, a drop in the total market cap of crypto as a whole has created a perfect storm for a black swan event in regards to the Terra ecosystem. Will Terra survive this storm, or are tens of billions of dollars worth of tokens about to be wiped from the face of the earth?
Regardless of whether Terra can recover, there are plenty of investors who will not be able to due to Anchor Protocol liquidations.
And it’s not a small amount, $133k.. was all I had man, seriously this shit is pretty much wiped me out besides a few k in savings. I’m fucked 10 ways to sunday
— Wicklidation (@Joe_Cool_Bitmex) May 11, 2022
Binance Coin [BNB]: Don’t overlook these crucial indicators
Disclaimer: The findings of the following analysis are the sole opinions of the writer and should not be considered investment advice
As the dust seemingly settled in the altcoin market, Binance Coin’s (BNB) price took shape within a bearish rising wedge (yellow). The end of this tight phase could result in a sharp swing in either direction.
With the price finally breaching the basis line (green) of the Bollinger Bands (BB), the buyers affirmed the gradual increase in their influence. But, with slightly weak indications on its technicals, the buyers need to negate the selling pressure on high volumes.
At press time, BNB was trading at $315.9, down by 2.97% in the last 24 hours.
BNB Daily Chart
After bouncing back from the $268-support, BNB formed a rising wedge on its 4-hour chart. Now, there are two possibilities from this. Should the pattern function as a continuation of the previous downtrend, a further drawdown will be likely. A bearish outcome would expose the alt to a potential test of the Point of Control (POC, red) before any further pulldown.
To affirm this outcome, bears would need to enforce a close below the lower trendline of the wedge. With the BB looking to curb its current volatility, the potential decline might enter a squeeze phase in the coming sessions.
On the other hand, there are chances for the buyers to step in at the $307-support. This trajectory may be possible due to the alt’s recent streak of higher troughs. An upwards breakout would position BNB toward the $357-level in the days to come. A close above $326 would boost the probability of this upswing.
The 4-hour RSI was denied a break above its half-line as it plunged lower towards the 44-zone. Furthermore, the -DI moved parallel with the +DI line and suggested that a bearish trend is still active.
Also, capital inflows took a hit while the CMF struggled to cross the zero-mark. However, any bounce-back from its current support range would confirm a bullish divergence.
Looking at its press time setup, BNB tilted slightly towards the selling market. The investors should watch out for a break outside of the current pattern to make any potential calls. Finally, keeping an eye on Bitcoin’s movement and the broader sentiment would be important to complement the aforementioned analysis.
Uniswap: Assessing the prospects of ‘true’ recovery for UNI
The cryptocurrency market has been at its lowest since the beginning of May 2022. However, that is not the case for Uniswap. UNI hasn’t rallied or even projected any sort of momentum for almost a year now.
A trip down Uniswap’s memory lane
Trading at $5.6 at press time, UNI seemed to be struggling to recover from the woes witnessed in May. In fact, it has already been placed under the critical support of $8.4. Tested multiple times in the past, this support level is essential for Uniswap if the token wishes to hike on the charts.
However, despite all the crashes and the dips, UNI did not see a single holder of the DeFi cryptocurrency leave the network. UNI HODLers remained where they were months ago.
Curiously, the total number of UNI holders didn’t just stay constant. Over the last one month, the total number of UNI investors has spiked by almost 3k. The number of Uniswap holders stood at 290k, at the time of writing.
Furthermore, UNI holders are unfazed by the events of 9 May and are surprisingly still bullish on the asset. In the last 24 hours alone, about 1 million UNI amounting to a total of $5.6 million was bought by investors as the crypto “recovered” by a mere 3%.
Furthermore, one of the biggest concerns going forward is the asset’s correlation with Bitcoin. Sharing a correlation this high, Uniswap has placed its investors under the threat of bearishness should BTC ever drop again.
Trading at $29k at press time, BTC has the attention of every trader and investor now. Especially since a further decline would impact the entire market. However, a close above $30k could do the opposite trick.
The last time all UNI investors were together in profits was back in May 2021 when UNI peaked at $48. This will be unlikely this time considering the ongoing bloodbath in the market.
In fact, the network-wide supply of UNI has also been sitting in losses for five months now. This may discourage new investors from entering, even at lows of $5.6. However, given the current situation, Uniswap is better off without more bearishness over the next few months.
Stellar: Answer the Q whether HODLing is still the way to go
Disclaimer: The findings of the following analysis are the sole opinions of the writer and should not be considered investment advice
At the time of writing, Stellar (XLM) was sailing below the lower boundary of its Pitchfork after the latest bearish engulfing candlestick on its daily chart. The latest selling spree has set up a bearish structure for XLM.
Any close below the current pattern could spiral into further losses by paving a pathway towards the $0.12-zone. At press time, XLM was trading at $0.1283.
XLM Daily Chart
Since XLM flipped towards the south from the $0.4-zone, the bears found renewed pressure to pull the alt and test the $0.16-mark (previous support). After a liquidation streak, the recent bearish phase saw a drawdown from this mark after an over 45% weekly decline towards its 17-month low on 12 May.
With the current structure exhibiting bearishness, the bulls need to make extraordinary efforts to halt the ongoing selling momentum. For this, they still need to propel high buying volumes. The current bearish pennant setup could play spoilsport for recent buying endeavours.
Any close below the pattern could lead to a near-term pullback towards the $0.12-baseline. Post which, the bulls would be keen to bridge the overextended gap between the 20 EMA (red) and the 50 EMA (cyan). In this case, a close above the Pitchfork would reignite the possibilities for any recovery.
The RSI underlined a visible selling edge while compressing in the 36-41 range. The investors/traders must watch out for a break beyond the current bounds to enter either buy/sell calls.
Over the last four days, the bearish CMF marked lower peaks on the daily timeframe. But, any bounce-back from the -0.1-mark would confirm the existence of a bullish divergence with the price.
Looking at the prevailing bearish pattern coupled with weak buying volumes, sustaining a rally for the bulls would be relatively tougher. Any break below the pennant could lead to short-term losses or an extended tight phase before the buyers show up.
Besides, investors/traders should factor in the broader market sentiment and on-chain developments to make a profitable move.
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