Our final article in the series leads us to TerraClassicUSD (USTC), previously known as UST. With a market cap of around $450 million, the now defunct stablecoin remains in the top 10 ranked stablecoins by market cap.
What was a US dollar-pegged stablecoin is now worth $0.04, and the former version of the Luna blockchain, now referred to as Terra Classic, has been halted.
Luna now refers to the new Terra 2.0 chain.
UST’s demise has unfortunately touched many, and since algorithmic stablecoins are still a fundamental part of the stablecoin family, they are worth understanding.
Perhaps what happened in the UST ecosystem can help in understanding the strengths and weaknesses of current and potential future projects.
The models that resemble UST most in the top 10 are Neutrino (USDN) and USDD (USDD).
Dai (Dai) differs in that users can only generate it by depositing collateral with a value exceeding that of Dai generated. Frax (FRAX) differs in its collateral being split into the algorithmic and fiat parts.
Out of the four, the wildest de-pegging swings have come from USDN. Ivanov, USDP’s founder, admitted the protocol needs tweaking to maintain its peg better in the future. Sun’s USDD is still relatively young, and the team proclaims that over-collateral will stabilize the coin. Does that work? Let’s take a closer look at UST.
UST’s dual-token model had UST as the stablecoin and Luna as the backing token. An intricate interplay between the two was meant to keep the stablecoin peg steady.
Very briefly, under such models, when the stablecoin price goes below $1, arbitrage opportunities incentivize investors to buy UST at a ‘discount,’ to be swapped on the protocol for the value of $1 per Luna, allowing the user to make a profit.
The incoming UST is burned, so supply is lessened by default eventually, increasing the price. The opposite happens when the cost of UST is higher than $1. Users can swap $1 worth of Luna for $1 value of USD, which leaves profits when sold on the markets.
These arbitrage opportunities were designed to help keep the price stable through a mint and burn mechanism.
In an attempt to understand what happened in early May, some put out the idea of a coordinated attack which others have touted as a conspiracy theory. According to a research report by Nansen, seven identified wallets called ‘initiator wallets’ swapped sizable amounts of UST for other stablecoins as early as the 7th of May, with some having already done so back in April 2022.
This led to an imbalance in the Curve liquidity protocols. Based on this onchain data, the Nansen researchers refute the idea of a sole attacker, meaning it is far more likely that some players identified vulnerabilities in the protocol and decided to exit.
This initial de-pegging initiated a spiral of events, which the Luna Foundation Guard tried to no avail to slow down.
It seems like the turning point occurred when Luna’s market cap flipped that of UST, causing a rush to ‘cash out .’ Some took losses and cashed out at $0.97/98, while others got caught up in a steep decline in the token prices, increasing panic and selling pressure.
Critics of the algorithmic model had already been sounding the alarm bells over the sustainability of Anchor’s high yields, fearing an exodus when these were reduced. Undoubtedly, the downfall of the protocol was caused by a set of conglomerating variables.
Some claimed that LFG’s buying of Bitcoin proves that algorithmic stablecoins do not work.
Others have said that having reserves without a plan deepened the crisis. However, David Morris argues that Nansen’s report shows that certain big players lost trust in the protocol. If this is the case, one wonders whether current purely algorithmic models can survive.
Vitalik Buterin refuses to put them all in one bucket and has highly praised overcollateralized models. Are we still in the early evolution of algorithmic stablecoins?