Terra Powered by Luna expressed:  LUNA can easily shoulder the outstanding liabilities of UST, it just needs time to recalibrate and confidence restored.  Something that will take more than a weekend.

Extreme volatility produced a series of collateral effects across the Terra ecosystem, primarily derived from the short-term peg deviation of UST and its impact on the volatility of LUNA and levers of the Terra protocol.

The Terra protocol mechanism is quite simple: When the supply of Terra stablecoins (like UST) goes up, the LUNA supply goes down. When the supply of Terra stablecoins goes down, the LUNA supply goes up.

As an algorithmic stablecoin network, Terra is akin to a decentralized, open-source central bank.

Assets (LUNA) and liabilities (UST) maintain parity by the Terra protocol acting as a market maker, inflating the LUNA supply during UST contractions and deflating the LUNA supply during UST expansions.

Terra is designed with explicit, real-time levers to combat the negative effects of endogenous collateral models (increasing tax rate on txs + cashflows to stakers) that traditional banking models cannot match.

Terra primarily achieves this via the on-chain swap mechanism that is baked into the protocol. Users can always go-to protocol to swap $1 worth of LUNA for 1 UST and vice versa. The system is designed to handle $20 million of redemptions (UST → LUNA) with a 2% spread.

The sharp price declines in LUNA were compounded by the sell-off of LUNA due to large amounts of liquidations on anchor protocol. During the market volatility, redemptions from LUNA → UST exceeded $80 million at times, forcing UST to trade at a discount on multiple venues.

This is primarily because the on-chain swap spreads inflated to 7 – 9% during the worst period, making the classic time-based arb opportunity fundamentally unprofitable on-chain since redemption slippage exceeded expected profits from the arbitrage.

LUNA’s sharper price fall compared to other assets is a function of Anchor building up leverage on LUNA/bLUNA with cascading liquidations leading to market sells of LUNA — fueling reflexive stress on the UST peg.

Plagued by the cumbersome nature of stress-induced decision-making of human agents in times of market volatility, it’s why central banks are exploring CBDCs. Algorithmic, calibrated adjustments of economic parameters are more effective than faxes and suits in meetings.

Terra Powered by Luna concluded, stating, As long as we create useful applications that people use on top of Terra, a strong locus of demand will always exist. Despite the extreme volatility, we will continue to build with only the highest aspirations for our community and onboarding the masses to a more inclusive and open financial system. Don’t count at Terra just yet, and we’re only getting started.