Luna and UST's death spiral returned to zero in 22 years, which is a cautionary tale. Let's see what happened.
1. ust algorithm stabilization mechanism
In short, you need to understand the stability mechanism of luna and ust first:
1. Creation of UST: Burn $1 of Luna at market price and you can mint one UST.
2. Destruction of ust: Burn one ust and you can mint luna at $1 market price.
When ust>$1: the market will have arbitrageurs who buy $1 of luna at the market price, burn it, mint 1 ust, and sell this 1 ust at a price higher than $1. The market completes the arbitrage, thereby driving the supply of ust and allowing ust to return to the anchor of $1.
When ust<$1: there will be arbitrageurs in the market who buy 1 ust at the market price, burn it, mint luna with a market price of $1, and sell this luna at $1. The market completes the arbitrage, thereby reducing the supply of ust and allowing ust to return to the anchor of $1.
Through the market arbitrage mechanism, ust is anchored to (peg) $1.
2. The spiral rise of ust and luna
Terra promoted UST by touting many advantages (defi, censorship resistance), but the most important one is the Anchor Protocol in the Terra ecosystem, a decentralized bank (savings, lending UST), where savings can provide an annualized return (APR) of 20%, and the income comes from the income from lending UST and the staking income generated by the collateral for lending UST (the collateral must be a staking currency such as ETH). The extremely high APR attracted many people to buy UST, which in turn boosted the demand for Luna, and Luna and UST spiraled upward.
3. The death spiral of ust and luna
Anchor Protocol actually does not have so much demand for loans, and the protocol income is not enough to cover the interest expenses, especially after the scale is large, relying on the project party for subsidies is unsustainable, so the protocol later lowered the APR. This led to large investors selling ust, ust decoupling, and then triggered a series of sell-offs, which directly drained the pool of Curve (a decentralized stablecoin trading pool). Then the market fud, and began to sell on the chain in exchange for luna, causing the price of luna to fall and liquidity to tighten, which in turn caused greater fud. Because of the liquidity tightening and extreme market fud, ust has been unable to return to the anchor, and luna has fallen wildly. The project party wanted to save the market, but the capital volume was not enough, so it could not be saved directly.
Using the market's arbitrage mechanism to stabilize UST is fine when there is sufficient market liquidity (the market has sufficient consensus on Luna and UST). Once liquidity tightens (usually leading to FUD, which will further tighten and fall), it will go into a death spiral and return to zero.
