I bought UST and deposited to Anchor without fully understanding the system (laughs). Now that the “stablecoin” has crashed, i’m cleaning up split milk and trying to make sense of what the hell I invested in.
Stablecoins
Stablecoins are coins that are pegged to the price of an external reference; this can be a major currency (USD) or commodity (like gold). The purpose of that is to make sure its price doesn’t change dramatically (like Bitcoin) which renders it unusable as a medium of exchange.
Eg: Tether (USDT) is backed by USD on a 1:1 ratio. Tether manages a reserve of cash and short-term debt corresponding to an equivalent amount deposited by its holders (currently it stands at $75 Bn). This means that you can always exchange $10 USDT to $10 in real life.
TerraUSD (UST) — Terra’s algorithmic stablecoin
UST is an ‘algorithmic stablecoin’ that was to be pegged to the USD.
But unlike other stablecoins that are actually backed by real cash/cash equivalents, price of UST was maintained by an interesting algorithm with another crypto-asset called LUNA.
The tagline for UST is ‘UST, powered by LUNA’.
Powered by LUNA
Terra blockchain is designed such that $1 worth of LUNA is worth 1 UST.
If UST rises above USD (ie. 1 UST= $2), investors buy LUNA and swap them for UST. They swap $1 worth of LUNA for 1 UST, and sell to market at $2 to make a profit of $1.
Swapping for UST increases the UST pool, and pushes the price of UST down. Simultaneously, since LUNA is bought and burned, LUNA pool decreases and $LUNA rises. Terra also automatically buys back more LUNA and burns the excess supply. Either way, $LUNA increases.
If UST falls below USD (1UST =$0.50), investors swap their UST for LUNA. 1 UST that is worth $0.50 can be swapped for $1 worth of LUNA, this earns them $0.50.
UST pool decreases and pushes price of UST up. Since LUNA is minted, LUNA pool increases and $LUNA decreases. LUNA holders are penalised if UST becomes less attractive.
This way, LUNA absorbs the volatility of UST via arbitrage activity of market participants.
On 5 Apr 2022, $LUNA was trading at $116 in the market.
The death spiral — fall in $LUNA
Since LUNA can be traded independently in the market (as $LUNA), it is subjected to the price volatility of markets. A general bear market can cause $LUNA to fall in value, like any other trading assets.
Unlike stocks whose prices are indicators of their earning/growth potential/company fundamentals, $LUNA is based on the value and use of UST. UST value is based on the usage of terra ecosystem as the platform for building decentralised smart contracts, dApps, DeFi, TradFi platforms, etc. This space is still largely unregulated.
The downside of an uncollateralised stablecoin like UST is that there’s no guarantee that the UST is going to be worth anything outside of the community’s faith in the terra ecosystem. You can’t use UST to buy Macdonalds or pay rent. The community was relying each other to push up the value of UST.
Prior to the crash, the main reason for people to buy UST was a saving mechanism called Anchor Protocol (ANC) that was providing 20% yield — significantly higher than most other investments. People buy UST, deposit their UST in Anchor, and earn yield in the form of UST. This also means that the demand for UST is very much focused on 1 area — Anchor Protocol. Before the crash, over 70% of UST was on Anchor. Not very decentralised.
If the yield for Anchor falls, and if investors are not confident of the future of UST, there will be a simultaneous drop in UST demand/price as well as $LUNA. As UST price falls, more LUNA is minted, leading to further price fall for $LUNA. There becomes too much supply of LUNA and people were (are still) not willing to buy worthless UST to swap for worthless LUNA.
And the original role of LUNA?
This double downward pressure of $LUNA prevents the token from performing its role of pegging UST to the market .This price of UST kept falling and was eventually depegged from USD.
When UST is depegged from USD, the market went crazy.
As mentioned, this peg was the main function of a stablecoin — to be stable. It’s like realising that Jesus was actually not the child of God, or that your mum was actually right about most things. The market reviewed their confidence in terra ecosystem and decided it was a no. Coupled by the weak fundamentals of an uncollateralised coin, the market began a panic sell-off.
I’m not sure of the exact cause of the double spiral of $LUNA and UST. Some speculated that big traders were betting against LUNA, or that Anchor Protocol recently decreased their APY.
All I know is as of time of writing, UST is worth $0.195970 USD, and LUNA is $0.00.
