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Algorithmic Stablecoins and the TerraUSDCrash

CRS Insight, Algorithmic Stablecoins and the TerraUSD Crash, May 16, 2022: “…TerraUSD (UST) stablecoinuses an arbitrage mechanism typical of some algorithmic stablecoin arrangements consisting of two coins or tokens: the stablecoin, in this case UST, meant to maintain a stable value or “peg,” and a balancer token, in this case,LUNA, the value of which can fluctuate. An algorithm manages the relationship between these two coins to attempt keeping the stablecoin pegged to the reference. If strong demand pushed the price of UST above its peg, arbitrageurs could buy $1 worth of LUNA, trade it for 1 UST (worth more than $1) and sell UST for a gain. If UST falls below $1, someone can buy $0.99 worth of UST and trade it for $1 worth of LUNA. In both instances arbitrageurs net a profit and ostensibly maintain the peg. Over the past week, UST lost its peg to the dollar (Figure 1), and both UST and balancer coin LUNA were dropped from various cryptocurrency exchanges. UST hit a low of $0.12 at 9a.m.on May 16, 2022…”

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