Thoughts and Opinions #2/ Peg me, Terra
Both $LUNA and $UST have been the subject of many debates last week. Before we get into the article, lets answer some primers:
How many % of the people in crypto are in for the tech ?
How many % of people in crypto just want to make money?
How many % of people in crypto feel a need to not hold centralized stablecoins (USDC, BUSD)?
Note that these groups are not mutually exclusive.
Recap: What is $Luna and $UST?
$LUNA is the native token of the Terra Blockchain. $LUNA can be used as gas fees on a transaction on the $LUNA blockchain. However, the biggest selling point or feature made by $LUNA proponents is $UST.
$UST is a decentrazlied uncollateralized stablecoin, ie not backed by anything. $UST is intended to be $1. $UST’s supply is elastic, meaning the supply will shrink or expand depending on the price of $UST in the markets. When $UST trades above 1 dollars, people can use $1 dollars worth of $LUNA to mint (create) $UST, and sell it for a premium on the market. When $UST trades below 1 dollar, people can buy $UST at a cheap price, and redeem it for 1 dollars worth of $LUNA. This is referred to as the peg mechanism. There’s also a seigniorage that does this automatically. Figure 1 illustrates it well pretty well.
The marketcap (Figure 2) of $UST has been pretty much been up only. So that means $LUNA has consistently been burned into $UST. $UST has also been bridged onto other blockchain ecosystems, such as the Avalanche and Ethereum blockchain, so it exists on multiple blockchains. It’s also supported by quite a few popular exchanges, such as Binance.
While $LUNA has its own blockchain, it isn’t as popular as other blockchains. So, the future of $LUNA pretty depends on the success of $UST as the de facto decentralized stable.
The case for $LUNA and $UST can be summarized in this single line thesis:
A decentralized economy requires decentralized money.
Arguments for/against $LUNA & UST
I am not going to go into great detail; most technical points have already been made elsewhere. Will mostly pen my thoughts and opinions on these points.
I would say that the $LUNA ←→ $UST mechanism works as intended. $UST also cannot be frozen, unlike $USDT or $USDC, so a person holding $UST can expect to always be able to transact with it. So yes, to a certain extent, we can say that the blockchain is decentralized, and $UST is decentralized and nobody can be discriminated from using it.
However, the success of the $UST is well, inextricably linked to its market price, since it has to trade at $1 dollar at all time. LUNA and $UST suffers from a major lack of decentralization of influence from major figureheads. I talked about this in my other post about decentralization. If Do Kwon, the co-founder, decided to quit working on terra today, I am sure that $UST will stand a pretty good chance of losing its peg. This is unlike Uniswap which would still function perfectly as a decentralized exchange if $UNI went to 0.
So, yea. I am kind of on the fence on this point.
2. Anchor Protocol
Anchor Protocol is a lending borrowing protocol paying out 19.5% APY interest on $UST. If you stake 100 $UST, you can expect to get 19.5 $UST in 1 years’ time. Where does the yield come from? A ballpark number of 10% comes from the protocol’s borrowing and lending function, while the other 10% comes from the yield reserves.
In my opinion, Anchor Protocol has been by far the greatest catalyst for $UST growth, with as much as 10.6b worth of $UST staked into anchor for that 19.5% APY. However, it is also, in my opinion, too big for its own good. Do the maths. 19.5% APY on 10.6b $UST means a rounded down 2b $UST interest year on year. And that’s crazily high.
I think it’s pretty agreed everywhere that 19.5% is unsustainable. Do Kwon had to already top up the anchor yield reserves once with 500m, which would probably buy $UST some time to shed its overreliance on Anchor.
2.2 Reward token
Another parallel I could draw is $UST being a reward token. In DeFi, a reward token is a token paid to users/liquidity providers for staking/farming/lending/borrowing. There is an old adage in DeFi - ‘Never buy a reward token’, because people can and will dump the reward token for safer assets.
In Anchor protocol case, $UST is one of the reward tokens, and well it’s a little bit of psyops since $UST is supposed to be that safer asset. $UST has that peg mechanism going for it as well, so I suppose people are less inclined to sell $UST to other stablecoins.
But lets say one day anchor loses its 19.5% APY on $UST to a very mediocre 10% (without yield reserves). What is the incentive to hold $UST when there are competitive and better yields out there? You could argue that $UST is used across other protocols. But lets cycle back to Figure 2 and 3. There is 10.6B in anchor, and the market cap of $UST is only 15.2B. That means 69% (hehe) of $UST marketcap is ALL in anchor. That’s pretty worrying.
Using $CAKE, the reward token of Pancakeswap as an example. $CAKE price action has been like a snail trying to crawl upslope but only falling back even more on a rainy day. 1 steps forward, 2 steps back. Rewards tokens usually don’t do well because they are well, a reward, meant to be spent, and also they are usually highly inflationary.
So, I am pretty sure that the overreliance of $UST on anchor is more of a bane than a boon. It has to get rid of this association ASAP.
3. Growth of $UST
One thing that puzzled me when I was reading about how much $LUNA has been burned into $UST last year was the price action of $UST. Lets recap how the peg mechanism works:
When $UST trades above 1 dollars, people can use $1 dollars worth of $LUNA to mint (create) $UST, and sell it for a premium on the market.
When $UST trades below 1 dollar, people can buy $UST at a cheap price, and redeem it for 1 dollars worth of $LUNA.
So based off this, you would think that $UST has been in high demand. that $UST traded sufficiently high above $1 such that it warranted the burning of $LUNA to UST. However, the $UST chart (Figure 5) seems to say otherwise.
For most part, $UST is pegged at 1 with slight fluctuations. There has been 2 major times it traded under peg (15% and 5.5% under), and twice it traded over peg (2.5% and 4% over). Since July 2021, there hasn’t been any major depeg events. If you look at Figure 2 again, $UST supply only really started increasing exponentially in Nov 2021. But $UST has been trading relatively stable at 1.
Turns out, $UST supply highly inflated because the Terra Foundation burned $LUNA minted more $UST for other purposes - such as increasing liquidity in other ecosystems, topping up Anchor’s yield reserves, and so on. I’m not going to link all the sources here, you can just google, it was widely reported. But here’s one
Would I say the growth of $UST is organic?
4. Burning Luna
I ended off point 3 with saying that the Terra Foundation burned $LUNA to create more $UST. So my immediate question was - where’s this $LUNA from? Market bought? Turns out these burnt $LUNA were from the treasury. Again, you can google the sources yourself, but here’s one.
If I have 10 diamonds = 1000 dollars. so one diamond is 100 each.
suddenly diamonds drop from the sky - there are 1000 diamonds now - would you still pay 100 each? Would you say that 10 diamonds is still worth 100k?
ok I’m not very sure if this is a good analogy, but my point is - $LUNA that is currently burnt is $LUNA that has not even hit the circulating supply and therefore the market. So why are these $LUNA valued at the market price? Supply and demand matters.
Secondly, it also means that $LUNA current price action is mostly due to speculators/traders/investors, because as far as I know there is no $LUNA market bought by the peg mechanism. I try to explain this in Figure 6.
Personally I look at it as sort of a conditional inflationary unlocking scheme - $LUNA is released from the treasuries in the form of $UST into the markets. It is similar to the unlocking of tokens from early investors, just maybe a little delayed and by proxy of $UST. It depends on the strength of the $UST peg to determine if $UST will be funneled back into $LUNA.
5. Bitcoin backing
5.1 Supporting the peg
Piggybacking off point 4, the use of $BTC has been recently announced to support the peg of $UST.
If $UST supply increases, portion of $UST will be used to market buy $BTC.
If $UST supply decreases, bitcoin reserves will be sold off to buy $UST
This will supplement the $LUNA peg mechanism, so I guess there is additional support for the peg for $LUNA. However again, the initial purchase of 3b dollars worth of bitcoin is minted from $LUNA that hasn’t really hit the market. So it’s sort of effectively using the current price of $LUNA to buy $BTC, except there is an intermediary $UST layer. This does not cause selling pressure on $LUNA, since $LUNA ←→ $UST is done via a smart contract, but it does create buying pressure for $BTC, since it is done via the market.
Pretty ballsy move, but could implode badly and have contagion effects across the whole crypto market.
5.2 Bitcoin Bribes
Do Kwon said in his Twitter Space with Udiverse that $BTC was chosen as the asset to support the peg because it is the most battle tested, resilient and decentralized asset in crypto, and nobody could argue that $BTC didn’t have its place in crypto.
I totally agree. $BTC is the hardest and most decentralized form of crypto asset that cannot be seized.
But I think the implications of using $BTC extends to more than simply adding an asset to the treasury. There are many (rich) bitcoin maximalists, and adding $BTC to support $UST peg is a pretty smart move to get them to open up to the idea of having an decentralized stable. I would imagine the conversation between 2 bitcoin maximalists would go like this:
A: Hey did you hear $UST is supported by $BTC now
B: yea i did. $BTC is da bes
A: Coool. Maybe $LUNA isn’t that bad huh
B. Yeaaa. $BTC is on da Moon…
It’s kinda like lobbying, except this time that you want to impress the king’s inner circle to get them to promote the court eunuch. or the butler. or the chamberlain. You get my point.
So, yup. Overall I think this was a smart move by Terra.
How does $UST compare to other stables?
Centralized stables such as $USDT, $USDC, and $BUSD all claim to have collateral backing its coin. $USDT (Tether) is the oldest, but is pretty much a black box. There has been several allegations against $USDT not having enough collateral, and Tether has not published any audits of its collaterals. $USDC (Circle) and $BUSD (Binance) on the other hand, do publish monthly reports of their collateral.
Decentralized algostables, such a $DAI, $FRAX or $MIM, use different types of collateral. $DAI uses a high % of $USDC along other assets their collateral. FRAX is partially collateralized, and $MIM uses debt as its collateral. The main argument against these decentralized stables is that their collateral is centralized (like $USDC), so it makes the algostable centralized too. In my opinion, having some form of collateral, centralized or not, is better than not having any.
7. Real life use
When I hear of a dollar stablecoin, my immediate reaction is to wonder if its spendable in real life. Can I buy McSpicy using this stablecoin? If I borrow money from my friend for a meal, can I repay him in this stablecoin? Can I put this stablecoin back into my bank? Dollars are meant to be spent anyway.
To be fair, I don’t have good knowledge on this. I know there are products (chai, alice) that are working to use $UST in real life. But I haven’t heard any widespread adoption of these apps. In contrast, Mastercard seems to be using $USDC. But again, this is just based off what i know. School me if i’m wrong.
Say, if I had 1million of $UST, and I wanted to buy a property. Unless I can find a broker who is willing to accept $UST, I still would have to convert $UST → $USDC → my bank.
$UST has quite a long way to go, and I suppose this applies to the rest of crypto as well in terms of real world adoption and usage.
8. Bet on macro inflation
I wasn’t really sure if I should put this in. But I guess I’ll just throw it in. $BTC has that narrative of being an hedge against inflation because money printer goes brrrr right? Then wouldn’t $LUNA be similar? If $USD printer goes brr, we can expect $UST marketcap to rise accordingly. $LUNA would probably benefit from further minting of $UST as well. So would $LUNA be a better hedge against inflation than $BTC? I dunno, this is just conjecture and theory.
Remember those primers at the start of the article? Good time to revisit them.
I think the intersection of the 3 circles is the ideal target audience for $LUNA and $UST. The question for you - How large do you think is this intersection?
Personally, I am more biased towards a larger portion of people in crypto for the money, and not so many people really care about having a decentralized stable or the tech. People ultimately want to cash out into a usable form
But I get the vision. It is a grand vision. It is a step in realizing a decentralized economy, and a decentralized economy can only be as decentralized as its most centralized component. Still, it is important to realize the risks - and those in point 2 and 4 matter a great deal to me.
Will $UST hold its peg? I have no idea. I am cautious though. Recent developments such as the BTC backing has definitely increased the confidence in $UST. I do hope $UST becomes the de facto decentralized stable across multiple ecosystems. Yet, $UST has to be careful not to fly too close to the sun and get too big for its own good.
Till future developments, happy farming in anchor.