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Crypto community comments on UST: Terra is convincing everyone that UST is truly worth one US dollar

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Crypto community comments on UST: Terra is convincing everyone that UST is truly worth one US dollar

"UST is a type of 100 Magic Dollars supported by 20 Bitcorns, metaphorically representing Bitcoin, and 80 Magic Beans representing LUNA. However, some people believe it is not worth 100 dollars, so LFG sells more Bitcorns and buys more Magic Dollars to convince the public that it is indeed worth 100 dollars, all in an effort to make Magic Beans holders less sad." This is how jonwu.eth metaphorically describes it.

Jonwu.eth, the Chief Growth Officer of L2 technology company Aztec Network, released a lengthy analysis after the UST decoupling, and this is a summary of it. His negative views on UST do not represent his position.

Original link: https://twitter.com/jonwu_/status/1523793482850050048

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For more information on the UST minting mechanism, arbitrage stability mechanism with LUNA, and the UST demand generated by the fixed-rate protocol Anchor, please refer to the link.

UST's Vulnerability: Sole Reliance on Anchor

jonwu.eth stated that Anchor, ostensibly a lending market, is primarily attractive due to its 19.5% interest rate, which is the main reason for holding UST. As a result, the circulation of UST is concentrated within the Anchor protocol. This has led to two issues:

1. If there is a 20% interest rate, why not borrow a large sum to achieve over 100% APY?

This is precisely the strategy of Abracadabra/MIM's Degenbox. The protocol allows for generating underlying income based on UST and obtaining higher returns through leveraged borrowing. Degenbox and the Wonderland ecosystem collapsed in January, causing UST to temporarily decouple, resulting in LUNA plummeting from $100 to $46.

2. How can a 20% interest be given out annually for free?

This is managed by the Luna Foundation Guard (LFG), which oversees the Terra ecosystem's multi-billion-dollar fund. Note: Due to Anchor's deposits far exceeding loan amounts, various subsidy policies have been continuously implemented by the LFG Foundation to cover the shortfall.

UST May Survive, But LUNA Could Go to Zero

The author pointed out that UST having a higher market value than LUNA is not the real concern; the issue arises when UST is redeemed for LUNA, causing a collapse in LUNA's price:

  • When LUNA's price rises: Users burn LUNA to mint a large amount of UST
  • When LUNA's price falls: UST is redeemed for a significant amount of LUNA

The author gave an extreme example:

Assuming the price of LUNA is $1 billion, someone burns LUNA to mint $1 billion UST, and if LUNA drops to $1, the individual can redeem $1 billion UST for 1 billion LUNA tokens, leading to a massive sale of cheap LUNA in the market. This is what is happening today.

Operations of LFG

The author noted that besides having stabilizing mechanisms like other algorithmic stablecoins, UST is backed by the LFG Foundation. They may operate as follows:

  • LFG sells off LUNA from its treasury to supplement the bribery fund distributed by Anchor to UST holders. All L1 funds do this, just not as directly.
  • Before the LFG funds are depleted, UST gains significant adoption and stabilizes the peg.
  • Users pledge UST for locking.
  • LUNA rises.

However, in times of significant market volatility, similar to other algorithmic stables, UST behaves inversely in downtrends and uptrends:

  • Users unlock and sell pledged UST.
  • UST decouples due to selling pressure.
  • UST holders redeem LUNA and sell.

The entry of Bitcoin complicates matters further. At the time, LFG completed a $1 billion private token sale financing through entities like Jump and 3AC, causing a massive surge in LUNA. Factors arising from this include:

  • Potential large and high-priced LUNA minting to generate UST.
  • LFG buys Bitcoin at an average price of over $40,000.
  • LFG may be forced to liquidate Bitcoin due to UST decoupling pressure.

LFG Market Support Operations

LFG recently announced pledging $750 million in Bitcoin, borrowing more funds to maintain the UST peg.

The author noted that the deeper UST liquidity, the more challenging it is for market sell-offs to decouple UST from $1, even if Bitcoin faces liquidation, which is preferable to a bank run caused by public panic about UST.

Therefore, potential outcomes include:

  • Depletion of LFG treasury stabilizes UST.
  • Bitcoin stabilizes around $30,000.
  • UST peg is restored.
  • LFG buys Bitcoin on dips.

A better scenario would be if Bitcoin suddenly surges, increasing the collateral value, making UST a fully collateralized stablecoin asset.

Another scenario the author deems unlikely:

Founder Do Kwon and LFG sacrificing LUNA holders, allowing UST holders to exchange at the initial collateral value for LUNA.