The madman’s trial: Can UST/LUNA go back?

As you may have noticed, things have been volatile in the market lately. The madness is driven by idiosyncratic factors, the bear market has been here for months, and the madness is largely driven by the risks of the Terra model.

As the circulating supply of UST grows, it gives upward momentum to the price of LUNA. This works very well in a bullish market, as demand increases as UST usage increases, allowing LUNA holders to see their tokens create value directly. In a safe-haven market, however, the same mechanism can create a problematic death loop.

Let’s take a quick look back at what happened to LUNA and UST and think about what exactly the Terraform Labs (TFL) team needs to do to ensure a bank run like this doesn’t happen again.


1. People prefer safe-haven assets. Macro conditions have clearly been deteriorating for some time now, with unsuitable global interest rates and deflation putting constant pressure on stocks and cryptocurrencies. This has led investors to move from undercollateralized stablecoins (UST) to fully cash/cash equivalents collateralized stablecoins (USDC, USDT). 

2. The underlying assets/liabilities of the UST do not match. The fact that UST can always be exchanged 1:1 for $1 of LUNA despite no collateral creates a direct relationship between token demand. In a rising market, mismatches are not a problem. In a down market, however, balance sheet concerns have become more apparent and algorithmic risk has proliferated.

what happened?

1. LFG first issued a statement to transfer $150 million of UST liquidity from the 3CRV + UST pool in preparation for the launch of 4pool. At the same time, an anonymous address bridged and sold $85 million in UST. 

2. The sale caused the Curve pool to become unbalanced and put downward pressure on the UST price. To help correct this de-anchoring, LFG removed another $100 million of UST liquidity from Curve.


3. But this is still not enough to make UST return to anchor, and panic has slowly spread among the crowd.

4. Due to the design of the protocol, the price of LUNA is always linked to the circulation of UST. However, in the context of large-scale bank runs, the price of LUNA fell rapidly, which meant that UST was destroyed and converted into more and more LUNA, which caused a potential death spiral and also brought the side effect of blockchain blockage.

5. This congestion has led to a further rise in people’s panic.

6. Positions in Anchor are mainly guaranteed by LUNA. The drop in LUNA prices resulted in the liquidation of UST, which in turn put further pressure on the price of UST.

7. TFL partners added over $280 million in non-UST liquidity to the 3CRV + UST pool in an attempt to stop the bleeding. This liquidity was quickly consumed as outflows were significantly higher than “bailouts”.  

8. A large amount of Anchor deposits has flowed out, and the UST market pressure has increased sharply.

9. These broken USTs have two destinations: they are still converted into LUNA worth $1, and the selling pressure of LUNA is stronger; they are sold out of the Terra chain, which intensifies the decoupling of UST.

10. Fewer USTs lead to more LUNA, and the price of LUNA will decrease faster

11. LFG then decided to borrow 750 million BTC off-site to help UST restore its anchoring. After the market normalized, it would loan 750 million UST to repurchase BTC.

12. The problem is that UST has become very cheap, so TFL’s ability to repay market makers has declined. If BTC is liquidated and sold, it will further drag the market and further exacerbate the death spiral.


By afternoon, the peg had recovered from a low of $0.66 to $0.90. Nonetheless, the price of LUNA has steadily declined as UST to LUNA continued to be sold in the market.


remaining questions

The key point of Terra Bear’s theory remains the lack of extrinsic yield protocols that interact with UST. Stablecoins are designed to be highly liquid trading instruments, however, with UST, liquidity is leveraged and highly concentrated on one platform. Anchor had $14 billion in deposits a week ago, while UST had a market cap of $18 billion. Obviously, there are a limited number of real-world use cases other than making money by depositing in Anchor.

This makes UST a riskier asset relative to other stable assets backed by cash or cash equivalents like USDC and USDT. UST generates returns in large part by compressing Anchor’s returns, and as investors shift from chasing yield to avoiding risk, the sole appeal of UST becomes less important. Even before the “4POOL” issue, funds had started flowing out of “Anchor”.

So, what is Terra’s solution?

1. First, the team must again build confidence in the algorithm and the entire model. Without it, the underlying “algorithm” won’t work. Selling pressure on LUNA will only last until there is enough money to support the peg. Having said that, there’s been a lot of talk about fundraising for the peg defense, and it really helps to dispel this fear of breaking the anchor.

2. Second, and most important, is to create use cases for UST outside of Anchor. While this has been an ongoing goal of the Terra ecosystem, it has yet to be achieved. If UST is held in the treasury, used in a pool, or truly integrated into DeFi, then bank runs will be much more difficult.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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