Thread by @NeBB399

Algorithmic stablecoins experienced a bright but fleeting boom over the last few months.

Amidst the ashes, @fraxfinance stands out as it popularized the fractional reserve model.

However, quietly chugging away under the debris is $UST by @terra_money.

A🧵below 👇

1/ As of 1 June 2021, $UST is in the top-5 stablecoin category by market cap at $2B. $DAI is in 4th place with $4.5B.

2/ Without going into too much detail, we do not consider $DAI an algorithmic stablecoin because it is overcollateralized and only backed by third-party assets.

For more info, see

https://twitter.com/NeBB399/status/1382629949161365504

3/ This makes $UST the only algorithmic stablecoin in the top-5 market cap.

But how has its peg held?

Well, throughout the first 5 months of 2021, it has had an average (daily close) of $1.002.

4/ Even when factoring into account $BTC's crash on May 19, the peg has held remarkably well and has since reverted back to normalcy.

This becomes even more impressive when you realize that $UST is one of the few algos which has no explicit collateral!

5/ $UST's peg is purely maintained by its arbitrage relationship with its share token, $LUNA.

Terra's system always allows $LUNA to be minted at a fixed exchange rate, irrespective of market conditions.

6/ Whenever 1 $UST < $1, $UST holders may exchange 1 $UST for $1 worth of $LUNA.

Whenever 1 $UST > $1, $LUNA holders may exchange $1 worth of $LUNA for 1 $UST.

This attracts arbitrageurs through profit incentives which inadvertently stabilizes the peg at $1.

7/ However, this is not uncommon as many other projects utilize an arbitrage strategy too (though with their own twists).

Some examples include @fraxfinance @FloatProtocol @feiprotocol.

$FRAX $FXS $FLOAT $BANK $FEI $TRIBE

8/ So what sets $UST apart from other protocols? Two things come to mind:

1. Linking $UST with Terra's validators (miners) through $LUNA

2. Facilitating real demand for $UST

9/ Point 1 - Unlike any other stablecoin, $UST is embedded into a blockchain network, i.e., the Terra chain, co-founded by both @d0h0k1 and @hyunsung1112 Terraform Labs.

This is unprecedented and offers network advantages to which no other stablecoin has access.

10/ $LUNA plays many roles in the Terra ecosystem.

Aside from acting as a peg stabilizer for $UST and governance token, it is also a staking token for mining rewards (given in the form of $LUNA itself).

11/ The staking element is key because only validators (miners) or delegators who delegate their $LUNA tokens may earn mining rewards (this includes airdrops from other Terra protocols).

However, to obtain these rewards, validators must have 'sufficient' $LUNA tokens staked.

12/ 'Sufficient' is relative as only the top-100 'active' validators with the highest amount of $LUNA staked are entitled to the rewards.

For some context, on 1 June 2021, the 100th validator had 500,217 $LUNA staked which amounts to $3.3M where $LUNA = $6.6.

13/ Essentially, to become an 'active' validator, you need to become a $LUNA whale. And since $LUNA is also a share token of $UST, an interesting relationship develops.

14/ One of the most significant threats to any seigniorage model is the price crash of its share token.

If the crash is significant enough, whales may lose faith in the system and flee to safer waters by dumping their tokens.

15/ However, since most $LUNA whales are validators, they are unlikely to abandon the network for several reasons:

1. Most whales are validators and are able to earn a relatively stable income (about 10-15% APY).

... (cont'd below)

16/

2. Validators have already invested significant resources into the network (e.g. time, mining rigs, application processes, etc.).

3. Even if validators wanted to leave there is a minimum 21-day lockup period where they cannot earn rewards or withdraw their $LUNA tokens.

17/ Terra’s system effectively transfer’s the risks of short-term volatility for Terra demand onto validators.

This brings more confidence to the system and encourages traders to continue arbitraging $UST and $LUNA without fear of holding a dead bag.

18/ Terra’s system effectively forces whales to cooperate by not dumping their $LUNA tokens.

Past experience tells us that this trait ('whale faith') is extremely valuable for community resilience.

Something which most protocols lack or substitute for with collateral.

19/ Point 2 - Users are spoiled for choice as there are numerous alternatives for stablecoins.

Unfortunately, choosing one over the other is often tied to convenience and ‘adoption by other applications’ instead of philosophical principles like ‘true decentralization’.

20/ However, since $UST is the native currency of the Terra network, Terra can create demand for $UST with their own applications.

As of 4 June 2021:

1. @anchor_protocol had $290M $UST deposited
2. @mirror_protocol had $1.3B $UST deposited for liquidity & mAssets

$ANC $MIR

21/ What most algorithmic stablecoin projects fail to achieve is to create demand for their stablecoins.

Offering liquidity mining rewards are often temporary and unsustainable.

No matter how complex the design mechanics are, there is no use case if no one uses it.

22/ Terra does the opposite of what most algorithmic stablecoins have done.

Instead of developing a currency within an established network (e.g. Ethereum blockchain), Terra has built its own country from the ground up.

This allows Terra to dictate the terms of currency use.

23/ As more projects launch on the Terra network, it is not impossible to imagine that $UST might dethrone $DAI and become the biggest decentralized stablecoin in the foreseeable future. Look out for:

1. @mars_protocol
2. @spar_protocol
3. Ozone Insurance

24/ There is so much more info to unpack but unfortunately, that is the thread limit.

If you are interested in learning more about $UST, $LUNA, and the Terra network (including the impact of $BTC's crash), check out our report on @coingecko at:

coingecko.com/buzz/unearthin…