Thread by @DeFi_Made_Here

Algorithmic stablecoins: case of $UST

Thread

1/ Disclaimer: I own $UST, $LUNA and a bunch of other coins on Terra. This thread is not about creating FUD, but I am asking reasonable questions and would love to have a discussion and listen to multiple points of views.

2/ What is $UST and how does it work?

$UST is an algorithmic stablecoin which is not backed by any type of collateral as over-collateralized or fiat backed stablecoins. #Bitcoin and #Luna don't act as a backing asset to maintain UST peg.

3/ Luna's purpose is to absorb the volatility in UST.

For each UST minted, one dollar worth of Luna must be burned. Luna maintains the anchoring of UST to USD through an arbitrage and seigniorage mechanism.

https://twitter.com/danku_r/status/1509173547788296195?s=20&t=lZBPIt9D-_hsd_W7Sv5iNw

4/ If the $UST price is >1$ there is an opportunity to burn $Luna, mint $UST, and take the difference to the peg as profit.

If UST is <1$, you can burn $UST for $Luna to restore the peg. Buy 1 UST for less than 1$ & get 1$ value of Luna. Then sell $Luna to make a profit.

5/ As the demand for $UST is constantly growing, Luna is being burnt day by day.

6/ What is the source of demand for UST?

@anchor_protocol is responsible for 74% demand for $UST - $12.3b out of $16.7b is deposited into anchor because of 19.5% APY on UST.

7/ In my opinion, while 74% of all UST being locked in one protocol, it is not a decentralized type of stablecoin.

https://twitter.com/stablekwon/status/1496170131042537477?s=21&t=XFToYvvsot7Wjgz4iE65lA

8/ How does the Anchor provide such a high yield?

This is a subsidized yield. Anchor is paying out interest on the deposits from the yield reserve which is getting filled from borrow APY. Real APY which Anchor can effort on its own is around 6% as of now.

9/ Last time yield reserve was replenished by LFG in the February by $450m:

10/ Since then anchor yield reserve is melting at a rate of $122m per month, which means that the reserve will last for another 3 months:

11/ And there is another question: where the money for replenishments are coming from?

12/ Does Anchor do something to increase yield reserve?

Anchor is adding new collateral assets: bLuna, bETH, wasAVAX, bATOM.

And increasing max TVL: 80% for bLuna and 75% for bETH.

It helps to increase Anchor profits but doesn’t change the situation a lot.

13/ Next step was to introduce anchor dynamic rates. As per this proposal anchor yield will decrease at a rate of 1.5% per month and the minimum APY is set to 15% (which will be reached in 3 months).

https://twitter.com/anchor_protocol/status/1507730612102254599?s=20&t=6Q5e-VLVLqya9UqNZnbG2A

14/ What are the risks involved with UST?

As the UST is not backed by any collateral and 74% of demand is based on a single protocol it is vital for Terra to maintain high APY in the anchor protocol.

15/ If Anchor yield reserve goes to 0 or APY falls below the point when people want to keep UST at Anchor, demand for UST contracts and LUNA might fall in price, as people will start selling UST, more Luna will be minted, supply increases and the price of Luna might fall further.

16/ Even if the UST peg holds, there is not enough liquidity on the market to absorb $12b of UST. Therefore you can expect $UST depeg which has already happened in the past:

17/ As I said, Luna's purpose is to absorb the volatility in UST. And if the MC of the UST will be higher than the MC of the LUNA there will be less of “backing” for $UST than $UST on the market (UST maxi say that price of $Luna HAS to go higher, which is, of course, not true).

18/ Ways to increase liquidity:

@stablekwon understands the problem and introduces a new 4pool on Curve which consists of UST-FRAX-USDT-USDC which might allow to stop replenishing the anchor yield reserve and have more liquidity to absorb $UST dumped on the market.

19/ Luna foundation has announced purchase of $1b worth of BTC for its reserves and plans to increase it to $10b. Terra now owns 35182 $BTC.

https://twitter.com/stablekwon/status/1503296630396645376?s=20&t=wdIq-3SVaov1iQa5rlsndw

20/ BTC reserve acts as an additional arbitrage / peg maintaining tool, as it allows to exchange 1 $UST for $0.98 of $BTC.

https://twitter.com/danku_r/status/1509173569032527874?s=20&t=lZBPIt9D-_hsd_W7Sv5iNw

21/ This was a great move to mint new $UST to buy $BTC and use it for $UST peg maintenance. But it is still around 10% of UST MC. If we assume the worst case scenario there is yet not enough liquidity to absorb UST sales. But why did LFG buy $BTC not $Luna for its reserves?

22/ What to expect?

I expect that Anchor yield will be maintained above the level people want to withdraw their funds and sell UST (15% maybe?) as long as there is not enough liquidity to absorb sell pressure.

23/ As soon as UST will get a wide adoption (74% in one protocol with artificial APY doesn’t mean real adoption), have deep liquidity across the chains and enough reserves to keep the peg, there will be no point to subsidize yield reserve so it will come to real market rate.

24/ Before that it will be a greater risk to hold $UST if the anchor yield reserve replenishments finish.

25/ Summing up, $UST holders have to understand that there is no liquidity on the market to exit from $UST for everyone at the same time, in return for this risk you are getting 19.5% APY (won't last forever).

26/ If you liked this thread, I would love it if you could share it by retweeting the first tweet:

https://twitter.com/DeFi_Made_Here/status/1512150353650884614?s=20&t=LKNhuf0st8d2-zpB3peASA

Thank you and stay safe!