Why has Terra's UST stablecoin caused LUNA to drop more than 20% in 24 hours?

According to data from CoinMarketCap, Terra's native cryptocurrency LUNA plunged from $83 on May 6, 2022, to $60.2 at the time of writing. This represents a massive 27 percent free fall. At the same time, the market capitalisation of LUNA also shed 22.84 percent, slipping from $27.41 billion to $21.15 billion.

The downward trend is being attributed to a recent FUD attack on TerraUSD (UST). FUD stands for "Fear, Uncertainty, and Doubt" and typically stems from a deliberate market move that spreads negative sentiments about an asset in the market.

In this case, one enormous crypto whale dumped $285 million worth of UST in the open market between 7 and 8 May 2022. The sheer size of the UST exit threw the token off its standard 1:1 peg with the US Dollar and pushed it down to $0.98.

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"Massive 285m UST dump on Curve and Binance by a single player followed by massive shorts on Luna and hundreds of Twitter posts. Pure staging. The project is bothering someone. On the right path!" tweeted Caetano Manfrini, Legal officer at GEMMA, a Brazil-based crypto firm.

Since the UST is pegged against the US Dollar, Terra maintains a collateral reserve in the form of its LUNA tokens. When the UST exceeds $1, users are incentivised by the Terra protocol to burn LUNA tokens and mint UST. The protocol reverses its incentives when the UST drops lower than $1. This strategy helps maintain stability.

As per a Messari blog, research analyst Will Comyns noted that "During times of UST contraction, LUNA valuation decreases, and during times of expansion, it increases. LUNA is the variable counterpart to UST. By modulating supply, LUNA's valuation increases as UST demand increases.

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According to the same Messari blog, vast amounts of the UST are concentrated in a few DeFi protocols like Anchor, a decentralised lending platform that promises high returns to UST depositors. When the crypto whale destabilised the UST-USD peg, it triggered panic withdrawals by investors from the DeFi platform.

According to data from the Anchor Protocol dashboard, the total UST deposits nosedived from 14.09 billion UST on 6 May 2022 (before the FUD attack) to 10.95 billion UST presently – a drop of 22.23 percent right there.

With such massive volumes of UST being dumped, its supply in the market skyrocketed. This led to a mismatch wherein the supply exceeded its demand, and here's where the protocol immediately switches over to incentivising miners to burn UST and mint LUNA. According to CoinTelegraph, this increase in supply in an otherwise stagnated or downward market could explain the drop in LUNA prices.

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