LUNA Supply Drops to All-Time Low – But Don’t Call It Deflationary

The supply of LUNA, the native token of the Terra blockchain, fell to an all-time low level on Tuesday – a price-boosting dynamic that's seen by crypto analysts as an indicator of how popular the project remains despite nagging concerns about its sustainability.

A lower supply of LUNA has helped to bolster the token's price in cryptocurrency markets; the price hit an all-time high of $119 on April 5.

“This results in a large price movement for the LUNA asset, as there is not only significant buying but also significant supply reduction," said Dustin Teander, analyst at blockchain data platform Messari. "Both forces push the LUNA price higher, leading us to where we are now.”

The Terra blockchain, founded and developed by South Korea-based Terraform Labs, has expanded rapidly from its roots as a crypto payment protocol for online purchases to new ventures in decentralized finance (DeFi), gaming and non-fungible tokens (NFTs). In the process, Terra’s native token LUNA and algorithmic stablecoin UST have leapt into the ranks of the top performing cryptocurrencies in 2022. The project also has drawn scrutiny about how sustainable its growth is.

The fate of LUNA’s price is closely linked to UST, as the LUNA token is essential to keep the price of Terra’s UST anchored to $1. The pricing mechanism to preserve the peg is built using an algorithm – an incentive for traders to step in and bring back the price to the peg – that permanently destroys and creates LUNA tokens to balance supply and demand for UST tokens.

When UST is above $1, LUNA is burned to mint UST. Similarly, if demand is low for UST and the price falls below $1, UST is burned to mint LUNA.

Read more: What Is LUNA and UST? A Guide to the Terra Ecosystem

The demand for UST has exploded, sending its market capitalization to $18 billion from $2 billion in a year as depositors flocked to the Anchor protocol, a lending and saving project built on Terra that has a market-beating 19.5% annual yield.

“In order to get the 20% yield, people needed to acquire UST, which involved first acquiring LUNA and burning it for UST,” Teander said.

Still, it does not make LUNA a deflationary asset.

If UST demand stalls and investors flee the Terra ecosystem, UST will be burned to keep up the price peg, diluting the supply of LUNA.

University of Calgary law professor Ryan Clements said to CoinDesk TV that Terra’s growth is likely “unsustainable,” calling all algorithmic stablecoins “inherently unstable” in a research paper.

In an extreme situation, the resulting sell-off in LUNA could trigger a downward spiral causing UST to lose its peg, sending shock waves to other parts of the cryptocurrency market, some analysts have warned.

Read more: Bailout Fund, Backstop or Bouncy Ball? Here's How LFG's Bitcoin 'Reserve' Might Work

This year so far, LUNA’s price has held up relatively well during a time when most cryptocurrencies have struggled, as red-hot inflation, rate hikes and geopolitical uncertainties drive investors to sell risky assets from stocks to bitcoin.

Since Jan. 1, LUNA slid by only 2.8%, while bitcoin dropped 18% and several major altcoins, such as solana (SOL) and cardano (ADA), lost about 40% of their value.

On Tuesday, LUNA jumped briefly to the sixth-largest cryptocurrency by market capitalization and fourth behind bitcoin (BTC), ether (ETH) and binance coin (BNB) excluding stablecoins, according to price tracker portal CoinGecko.