Original source: Glassnode

Original source: Glassnode

Bitcoin market had a historic week, $40 billion LUNA/UST project overinflated and collapsed, LFG sold 80,000 BTC, Tether’s $1 peg was under pressure, stablecoin supply shrunk by $7.5 billion, And Bitcoin's drop is close to the realized price.

The exchange rate of two stablecoins UST and USDT took center stage as the cryptocurrency market endured a historic week of volatility and chaos. In just a few days, the top ten digital assets by market capitalization (LUNA and UST) wiped out nearly $40 billion in value from investors. UST has completely de-pegged from the US dollar, while LUNA due to its over-inflated supply, the price collapsed, falling to $0.00001. So the Luna Foundation Guard (LFG) deployed their recently purchased reserve of 80,394 BTC in an unsuccessful attempt to salvage the dollar peg.

Later this week, driven by news of UST’s decoupling, the market temporarily had concerns about the quality of Tether’s (USDT) peg. USDT briefly fell to a low of $0.9565 against the U.S. dollar, but returned to normal levels within 24 hours, and currently maintains an exchange rate of 0.998 per U.S. dollar, with a small difference between the two.

Stablecoin panic spreads everywhere, LFG sold $3.275 billion worth of Bitcoin, and Bitcoin fell 21.2% to $26,513 under the weight. This is the lowest price since December 2020, naturally putting much of the market under financial stress.

In this week's chain report, we will introduce these three key topics, namely:

• The market dynamics of UST and LUNA, the supply of LUNA and UST, and how LFG's Bitcoin reserves are deployed.

• USDT’s brief depegging, and how it affects the market’s perception of other stablecoins like USDC, BUSD, and DAI.

• Bitcoin is gradually approaching the realized price, which has historically been an important support level, and the observable market reaction to this event.

LUNA Spectacular Falls and Reflections

Over the past few years, we have seen stablecoins make up a significant portion of the total market capitalization of digital assets. On May 8, the USDT, USDC, BUSD, DAI, and UST stablecoins were worth more than $135 billion.

There are many types of stablecoins, but they can generally be represented by three types:

• Mortgage coins (USDT, USDC, BUSD)

• Cryptocurrency Overcollateralized Coin (DAI)

• Algorithmic Stablecoin (UST)

As for UST and LUNA, the algorithm is designed to allow users to exchange 1 UST for LUNA worth $1 (and vice versa), regardless of the market prices of the two assets. Effectively, this means that when there is demand for UST, the supply of LUNA shrinks (and the price rises). However, this counterforce also works in reverse, when demand falls and prices fall, the supply of LUNA can (and has been) overinflated.

On May 9, when UST began to depeg from the US dollar, the price of LUNA was around $60 (down 49.5% from its previous all-time high of $119). Over the next 36 hours, LUNA price dropped below $0.1 and UST traded between the extremes of $0.30 and $0.82. This sent the protocol redemption mechanism into overdrive, as all users panicked and were exchanging 1 UST for $1 worth of LUNA, causing a rapid inflation of the supply, further driving down the price.

At the time of writing, LUNA is now at $0.0002 (down 99.9998% from ATH) and UST is stable around $0.1251, well below the desired $1 peg.

We can see the magnitude of the LUNA supply inflation in the chart below, with UST supply (green, RHS) scaled linearly and LUNA supply (red, LHS) scaled logarithmically. Over the course of a week, 7.5 billion UST was redeemed (40% of the supply), while the supply of LUNA ballooned from 343 million to over 6.53 trillion, an annualized inflation rate of 99,263,840%.

At one point on May 13th, the project even suspended the LUNA blockchain because the over-inflated supply had a second-order effect on network stability and governance.

The Terra blockchain officially stops at block height 7607789. Terra validators have shut down the network and are preparing a plan to reorganize the network. More updates are coming soon. --Terra (UST) May 13, 2022

With the UST peg trading lower, the Luna Foundation Guard began deploying their Bitcoin reserves, which they recently purchased, in an effort to stabilize the USD peg. Their total reserves have accumulated to 80,394 BTC in recent months, with the largest acquisitions occurring between March 21 and May 5. The total realized value of their Bitcoin holdings when they were added to their wallets was $3.275 billion.

These wallets were completely emptied within 21.5 hours between May 9 and 10.

As shown in the figure below, LFG's bitcoin balance was emptied three times. The first batch of bitcoins (22,189 BTC) worth approximately $750 million was deployed, and at 3:30 on May 9, the peg price of UST dropped to $0.98. A second batch of 30,000 BTC ($916 million) was deployed 15 hours later, and a final batch of 28,205 BTC ($873 million) was emptied from wallets 6.5 hours later.

Between 18:30 on May 9 and 01:10 on May 10, there was a series of exchange inflows of equal size (shown in blue) as market makers hired by LFG moved bitcoin between custodians . According to our assessment, the original destinations of these coins were:

• 52,189 BTC were sent to the Gemini exchange via OTC (these funds were soon deployed elsewhere, including the Binance exchange)

• 28,205 BTC were sent to Binance via direct transfer

LFG later confirmed that they had sold almost all of their bitcoins, leaving only 313 BTC in their inventory as of May 16.

As of now, the remaining reserves of the Foundation are composed of the following assets: 313 Bitcoins, 39914 BNBs, 1973554 AVAXs, 1847079725 USTs, 222713007 LUNAs (of which 221021746 are in the state of validator pledge)

During this period, the total balance of the exchange increased by about 88,000 BTC, which is more than the 80,394 BTC deployed by LFG. This bodes well for the contagion and panic these events have sparked, as Bitcoin investors add to the sell-side pressure. On May 14, there was a significant outflow of funds from Coinbase, although Coinbase does not appear to be a recipient of LFG-sourced Bitcoin.

The Contagion of Volatile Coins

As if this week hadn’t experienced enough turmoil, Tether (USDT), the largest stablecoin by market capitalization, also experienced decoupling pressure on May 11. While UST is large ($21 billion), many consider USDT, at $83 billion, to be systemically important to the market in its current form, being the dominant quote pair on many exchanges.

From noon on May 11 to noon on May 12, the price of USDT broke away from the $1 peg, reaching a low of $0.9565, before recovering within 36 hours, eventually recovering to $0.998. During this period, other major stablecoins USDC, BUSD, and DAI have experienced premiums of 1% to 2% as investors shift to assets they perceive to be less risky.

Tether announced on May 12, when the decoupling pressure was at its worst, that the redemption is still open, and the redemption worth $2 billion is already in progress.

Amid high market volatility, Tether continues to offer redemptions to verified customers and is processing $2 billion in redemption requests today.

If we look at the supply of USDT, we can see that indeed over $7.485 billion USDT has been redeemed this week. The total USDT supply dropped to $75.75 billion from an ATH close to $81.237 billion. As we noted in our report last week, the supply of stablecoins has recently contracted by $2.9 billion, the largest in history, driven primarily by USDC. So an outflow of this magnitude has now put the week ahead on this metric.

We also saw interesting changes in the supply of other major stablecoins this week, providing insight into market preferences in times of stress. USDC reversed the supply contraction trend since late February, adding $2.639 billion. Given USDC’s dominant growth over the past two years, this could be an indicator that market preference is shifting from USDT to USDC as the stablecoin of choice.

Another stablecoin that saw a huge change in supply was DAI, which saw its supply drop by 24.4% as $2.067 billion was burned. DAI is an over-collateralized stablecoin backed by other digital assets deposited in the Maker protocol. As token holders liquidate their positions by paying back and burning DAI, the supply of DAI will shrink.

This process may be arbitrary or forced in the event of a vault liquidation. However, despite volatile collateral assets, rising demand for DAI, and liquidation events, DAI has managed to maintain a strong $1 peg with only a very small premium.

Severe loss of on-chain implementation

As the LUNA saga progressed, the bitcoins acquired by LFG were sold on-chain at a much lower price than when they were purchased. USDT’s peg to the U.S. dollar has also come under pressure, with the price falling below the $29,000 support level set in July 2021. This has effectively put all investors in the red for the 2021-22 cycle and generated large and wide-ranging net losses.

The net loss realized by all on-chain consumption has reached more than 2.5 billion US dollars for two consecutive days, which is comparable to the largest capitulation event in history (if considered from the sum, the loss is the largest in history).

LFG alone contributed $703.7 million in realized losses. Note that this reflects losses between bitcoins entering and leaving LFG wallets, and does not take into account additional losses when BTC is traded into UST and LUNA with overinflated supply.

As the size of the Bitcoin market increases, losses in dollar terms will naturally increase over time. Therefore, we can create a"relative realized loss"Metric that divides daily realized losses across the network by realized market capitalization to compare losses across periods.

Here we can see that the LUNA capitulation still triggered one of the largest loss events of the past 5 years, incurring a total loss equal to 0.28% of realized market capitalization. This drop can be compared to the following events:

• The 2018 Bear Market Begins and Ends Selling Events

• March 2020 COVID-19 Crash Events

• The May 2021 sell-off, interestingly, is celebrating the one-year anniversary of that event this week.

Achieving prices are close at hand

Realized price is the oldest and one of the most fundamental measurement concepts in on-chain analysis. It is calculated by dividing the realized market cap (the sum of the prices of all bitcoins when they were last moved) by the circulating supply. As such, it reflects an estimate of the total cost basis of all bitcoins in the supply.

Historically, the realized price has provided good support in bear markets and provided a signal of a market bottom forming when the market price fell below it. The table below shows previous bear market cycles, and the percentage of time the price was below realized price.

It can be seen that each bear cycle has relatively less time below the realized price over time. This may be partly due to general awareness of its existence (it was first spotted in 2018). March 2020 remains the most pronounced deviation, with just 7 days below realized prices, rather than several months as in previous cycles.

When the market reached this week's price low of $26,513, the realized price was at $24,000. Spot prices dropped to within 9.5% of realized prices as the market collapsed under the weight of LFG BTC sales, value held by LUNA and UST was destroyed, and fear of Tether.

Due to the aforementioned total realized losses, the realized market capitalization fell by $7.92 billion, representing a capital outflow from the Bitcoin network and causing the realized price to drop by $60 to $23,940.

Despite the volatility, the bulls in the market seemed to react strongly as prices fell to realized prices. The chart and table below show the Accumulation Trend Score, which will return values ​​close to 1 when a significant portion of the market is increasing their on-chain balances.

On Thursday, May 12, when the market was at its lowest point, the Accumulation Trend Score reversed from a very weak value below 0.3 to return above a value of 0.796. Supporting a rally to $30,000, the score returned to above 0.9 for the rest of the week, indicating strong buying activity.

We can further confirm this by looking at the various wallet groups participating. We can see a rapid reversal from a weak accumulation (<0.3, warm colors) for all groups in early May to a strong accumulation (>0.7, cool colors) for most groups this week.

Holders of small amounts of Bitcoin (<1BTC) are by far the largest accumulators and are backed by whales with over 10k BTC (this includes fully allocated LFG balances). Groups of wallets holding 100 BTC to 10,000 BTC are still weaker in terms of their net accumulation.

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Unpublished metrics from Glassnode engine room

What happened this week is historic in nature, yet in many respects, has the hallmarks of a textbook bear market in digital assets. There have been various examples of big-name cryptocurrency projects turning out to be unstable and eventually collapsing under their own weight. Such events are often spawned by the downward price pressure of a bear market, as demand weakens and experimental systems (often leveraged) come under pressure.

As stablecoins increasingly become the base layer infrastructure in the market, the shock wave of the decoupling event, especially the decoupling of the largest stablecoin USDT will have a wide-ranging impact. The dual power of UST and USDT decoupling, about $40 billion in LUNA/UST value was wiped out, and LFG increased the selling pressure of 80,000 BTC, creating a perfect storm. This incident will undoubtedly quickly attract the urgent attention of the regulatory authorities.

It remains to be seen whether a full return to realized prices will be required to calm this bear market, and if so, months, weeks, days or just a brief moment. If the accumulation we observe shows that the bulls are willing to provide support in the $20K range, those days may be over. Also note that there are still plenty of macro, inflation and monetary policy forces acting as headwinds. The road ahead may still be bumpy.