Published: March 9th, 2022
A number of tokens issued by leading layer 1 networks have been hammered this week as market leaders like Solana, Terra, and Cosmos suffered drops of five per cent or more.
Ethereum, the number one smart contract platform, fell by more than three per cent on Monday, 7th March from just over USD 2,600 to under USD 2,500. ETH has since bounced back, but the damage to other protocols has lingered.
An announcement by Fantom Network that developer Andre Cronje would be leaving the DeFi leader saw its value sink by 12 per cent to USD 1.30.
Cronje played a central role in expanding the Fantom ecosystem with the launch of Solidly, a new decentralized exchange. Solidly had lifted the total value of all Fantom network projects. On news of his departure however, the network has experienced a crypto version of capital flight.
Alongside Fantom, both the Near Protocol and Cosmos fell in value by close to five per cent, while Solana dropped by closer to six per cent. Terra, a fast-growing layer 1 blockchain responsible for both the UST stablecoin and the LUNA token, had also lost close to four per cent of its value after an extremely bullish week (the week commencing 28th February).
Smaller layer 1 networks like Harmony and Kadena were also down 4.4 per cent and 4.2 per cent respectively, according to figures from CoinMarketCap.
A layer 1 network is a blockchain that can be used as a sort of base layer for building new crypto applications. It's designed with built-in tools that simplify the creation of things like non-fungible tokens (NFTs), or money markets where users can store stablecoins. Executing a transaction on the network typically incurs a fee which is denominated in a cryptocurency native to the blockchain.
Bitcoin and Ethereum are the biggest layer 1 networks, though Ethereum is the one favoured by developers as its in-built tools make it easier for developers to code. Most of the competing layer 1 networks have their sights on Ethereum, trying to chip away at its dominance by offering faster transaction speeds and lower transaction fees.
As of this week however that rising tide of Ethereum alternatives has lost a significant amount of market allure.
While layer 1 cryptos took the brunt of the bearish turn, the trend has spread out across the broader crypto market.
Bitcoin, the biggest crypto by market cap, began the week in a struggle to push above the psychologically important USD 40,000 level. By mid-week it had recovered, however.
Terra network, the rapidly rising network behind LUNA and UST, took a four per cent hit to its value this week. Terra is a DeFi tool kit built on Cosmos and the second-largest ecosystem in decentralized finance.
That’s a notable fall from last week. According to numbers from blockchain analytics firm DeFi Llama, as of Friday 4th March, Terra boasted a total value locked (TVL) of just over USD 23 billion, marking an all-time high in US dollar terms.
That’s roughly double what runners-up Fantom and Binance Smart Chain were able to pull in TVL in the same period. Ethereum retained its dominant position at 55 per cent of the DeFi market, and TVL north of USD 112 billion.
Some analysts have pointed out however that if Terra’s TVL had been expressed in LUNA, its native token, the picture would have looked different. In that scenario, last week’s spike looks more like a blip compared to activity seen last Summer.
This suggests that alongside a jump in real activity (users pouring crypto into the network to execute DeFi transactions), the primary driver for the network last week was LUNA’s mooning price action.
Figures from CoinGecko tracked LUNA’s rise at more than 37 per cent over the previous week (wc 21st February). In the same timescale, Anchor Protocol (ANC) the native token behind Terra’s largest DeFi project, also leapt by more than 70 per cent. Anchor is a money market similar to the Aave project on Ethereum, where users can earn close to 20 per cent on the UST stablecoin.
As price action gave the Terra ecosystem a boost, there were varied reasons why.
LUNA only started trading on the FTX Exchange in February, for example. But the real driver may be a LUNA token sale netting USD 1 billion for a Bitcoin treasury. A position opened by Three Arrows Capital and Jump Crypto sparked a rise on 23rd February. Analysts have speculated that the move is behind the creation of a new ‘UST Forex Reserve.’
It's believed that the non-profit Luna Foundation Guard (LFG), which supports the Terra network, will be able to add backing for UST with a non-correlated reserve as a hedge against price volatility. The thinking is that the new UST Forex Reserve will help keep UST pegged to the greenback.
The non-correlated reserve status is important because of the underlying structure of both LUNA and UST. Whenever a dollar of UST is created, A dollar of in LUNA is destroyed. The reverse is also true.
That opens the door to arbitrage opportunities for savvy traders. If UST dips below a dollar, traders can still buy the UST and swap it for a dollar’s worth of LUNA while trousering the discount. When the UST is purchased and swapped, it’s also burned and taken out of circulation. That keeps a lid on supply and helps keep its price at the USD 1 dollar mark.
Inversely, as more LUNA is shredded to create UST, the circulating supply of LUNA goes down, providing a similar boost in value.
The strict supply-and-demand relationship between LUNA and UST makes introducing an unrelated asset like BTC to the equation helpful. Luna Foundation Guard gains a mechanism to help sustain UST’s dollar peg.