Chinese Government Advised to Regulate Stablecoins in the Aftermath of LUNA Crash
There is a suggestion for the Chinese government to extend its cryptocurrency regulation to cover Stablecoins also. This is coming after hundreds of thousands of crypto users around the globe became victims of a crashed coin, LUNA. The LUNA crash became one of the major outcomes of the recent cryptocurrency bear market in addition to its associated Stablecoin, UST.
LUNA’s fall from glory took the majority of users unawares in what could easily be described as a soap opera of tragedy and loss. From what seems a strong position, with a market value of over $40 billion, and a population of hundreds of thousands of users, the LUNA cryptocurrency crashed to an almost insignificant value. Moreso, the crash happened within a very short space of time, leaving users with little opportunity to react and save their investment.
Adding to the complications of the situation is LUNA’s direct link to the UST Stablecoin. The UST Coin was developed by Terraform Labs as an algorithmic Stablecoin. Terreform Labs’ public chain token is LUNA. As a Stablecoin, the goal of the UST Coin is to be linked to the US dollar on the ratio of 1:1.
According to Yu Jianing, executive director of the Metaverse Industry Committee of China Mobile Communications Federation, in efforts to maintain the ratio of 1:1 value anchor between UST Coin and the US dollar, Terraform uses LUNA as UST, making it a de facto collateral behind the coin. This was targeted towards providing value support for the UST Coin. Hence, 1 UST Coin equaled 1 LUNA Coin which would be equivalent to 1 US dollar.
What this implied was that if the price of 1 LUNA is equal to 1 USD, then it can directly be exchanged for 1 UST Coin. Similarly, if the price of LUNA rises to even as high as $20, then it can also be exchanged for 20 UST Coins. This protocol also affected the minting and Coin burn process of both coins. The setup was such that whenever 1 UST Coin is minted, 1 US dollar worth of LUNA coins must be burned.
The algorithm behind the UST Coin protocol that was aimed at guaranteeing its stability involved other complex processes. To attract investors and encourage them to hold UST Coins, Terraform also launched what is called the AnchorProtocol. This allowed users to deposit UST Coins and get an annualized interest at the rate of up to 20%. This seems an appetizing offer that triggered an astronomical rise in price and overall value of LUNA in 2021. From below $1, the price of LUNA increased to $119.5 with a market capitalization of over $41 billion.
As stable as the setup appeared, there were underlying risks that turned out to be unprecedented. “Algorithmic Stablecoins do not have collateral assets, neither do they have any value support. They are designed to adjust the price of the Stablecoin to maintain the price of the currency anchored around a certain value. They also have weak resistance to price fluctuations caused by speculative behavior.”
Describing the crash of LUNA, Yu Jianing explained that it was a result of the sharp correction of the virtual currency market, of which the dynamics that followed became too much for the project’s algorithm to manage. According to Yu, as the market corrected, UST whales embarked on a sale adventure which caused the market to panic, triggering a de-anchor scenario for the UST Coin which lasted for a long time.
Massive selling of UST Coins followed this process, which resulted in more minting of LUNA, thereby increasing supply to high levels. This caused the price of LUNA to keep falling until the cycle went back to the beginning. This development resulted in massive losses for LUNA holders as they lost almost everything. Chanpeng Zhao, the founder of Binance recently stated that the value of LUNA held by his exchange dropped from $1.6 billion to about $2,200 within one month.
The fall of LUNA which triggered a collective drop in the virtual currency market has exposed further weaknesses in the design of Stablecoins. This has raised further discussion over more regulation on the industry, with attention given to Stablecoins. Zhou Maohua, a macro researcher at the Financial Market Department of China Everbright Bank thinks that China speeds up the completion of regulatory shortcomings, and introduces targeted regulatory measures for the risk of stablecoins. He believes that this will further reduce the channels for virtual currency speculation and protect citizens from such risks associated with the system.