The Flaw That Caused LUNA/TERRA To Crash
In just five days, May 7th through 12th of 2022, the UST/LUNA crypto stablecoin was hacked resulting in a market crash that has yet to recover. UST is an algorithmic stablecoin that maintains a value equivalent to 1 USD through a continuous auction with its partner coin, LUNA. To acquire UST you must first purchase LUNA and swap it for UST. LUNA coin is burned when this swap occurs meaning supply decreases and price increases. In theory, the system works because if UST falls below 1 USD to something like $0.98 people are incentivized to buy large amounts and sell for 1 LUNA. People are conversely incentivized to sell UST when the price rises above 1 USD. This system relies on the elastic supply of LUNA and well-incentivized arbitrage traders.
This system is a continuous auction. When UST falls below 1 USD an ascending-bid auction begins until the price rises to 1 USD. When UST rises above 1 USD a descending-bid auction begins until the price falls to 1 USD. The continuous buying and selling of UST mean its value is constantly fluctuating. But what led to its crash?
UST was depegged from USD meaning that the value of UST changed drastically compared to USD and the LUNA/TERRA system could no longer support a stable value of 1 USD. This occurred through multiple large-scale sales of UST by an unknown party. It was thought that the large LUNA reserves could resist even the largest fluctuations, but the value of LUNA tumbled because big investors lost trust in LUNA. Terra executives couldn’t keep investors happy as big funds started selling all their UST.
https://www.forbes.com/sites/lawrencewintermeyer/2022/05/25/from-hero-to-zero-how-terra-was-toppled-in-cryptos-darkest-hour/?sh=14b54358389e