In just three days, the price of Luna, the algorithmic stablecoin project in the top 5 cryptocurrency market capitalization, quickly dropped from US$120 to zero, and the market value of its US dollar stablecoin UST fell from 18 billion to less than 2 billion US dollars. Some people are worried about whether this crash will have an impact on Wall Street and the macro economy. The recent speech by US Treasury Secretary Yellen also mentioned the supervision of stable coins and the significance of the collapse of UST on regulatory reflection.
In the past few days, LUNA, no matter which price it was bought at was 100, 10, 1, or 0.1 US dollars, the decline would be the same 99.99%. Although there were two rebounds in the middle, it could not be saved. Why did LUNA experience such a one-way, return-to-zero decline?
LUNA'S DEATH SPIRAL
Jiang Jinze pointed out that the whole story of LUNA’s death spiral was because the project side chose the wrong rescue method. Terra and LUNA were the first projects that his team invested in at the time. At first, they found them incomprehensible and seemed like they were trying to create dollars out of thin air. As I looked at it, I felt that the design was great, but at the same time, I felt that there was a risk of collapse.
At the beginning of the collapse, Jiang Jinze felt that it could still be saved, but the team did not use appropriate methods to save it, and eventually fell into a death spiral. But looking back, the design of the LUNA model still has reference and inspirational significance.
LUNA was established in 2018. At the end of 2020, its market value was only tens of millions. Before the collapse, its full circulation market value was US$80 billion, which is equivalent to an increase of more than a thousand times in more than a year. LUNA started out as a token stablecoin system and designed a dual-currency system: burning and creating a tightly bound token UST.
Design of dual currency system
There is an oracle in the system, and the nodes on it will report the fair price of LUNA in the secondary market at this time. It is equivalent to selling LUNA to the system and you will receive the amount of UST corresponding to the value read by the oracle. Vice versa, two-way exchange.
In this process, if you want to make LUNA rise, you need to destroy LUNA and mint UST. There must be usage scenarios in this process. Otherwise, why not use BTC? At this time, South Korea's second largest payment group invested and endorsed and developed a stable currency for consumption and payment scenarios.
At that time, Mongolian dollar, Hong Kong dollar, Singapore dollar and Japanese yen were made. More than a dozen stablecoins have been generated one after another, but because the exchange rates between these stablecoins are constantly changing and unstable, it is no different from burning coins to generate stocks.
UST is indeed convenient for online payment, and there are actual e-commerce implementation scenarios in Mongolia, South Korea, etc., but the local payment tools are not very good. The daily activity can reach hundreds of thousands. This number is already very good in the blockchain field, but it is still tepid compared to later ones. At the end of 2020, the scale was only US$20-40 million. DAI had a market value of several billion at that time.
The emergence of Mirror protocol
Later, Terra launched a synthetic asset application called Mirror. The Mirror protocol supports over-collateralization of USD UST and maps it into stock tokens. The stock tokens use oracles and arbitrage mechanisms to closely follow the price trend of real stock targets. There are stock-mapped tokens of dozens of leading companies such as Google, Amazon, and Tesla that can be traded by users.
Because the collateral is greater than the secondary market token market value, users do not worry about insolvency (i.e. over-collateralization). Mirror (token MIR) has a liquidity pool for people to trade. To put it simply, when users deposit UST, the annual rate of return is as high as 1,000% at first, and then gradually decreases to 40-100%.
The emergence of the Anchor protocol
Later, Terra launched a very important application, Anchor, where users can earn high profits by depositing UST. At that time, everyone was discussing the good applications of fixed income, because the income from mining was unstable before, and it became lower and lower as time went by. Expected uncertainty is high.
Anchor's own design is a deposit protocol called algorithmic stable income. Its own design is not a simple "Ponzi scheme", but gives you a current income of 19.5%. As long as you put UST with zero casting cost on it, you can get stable and high returns. Such a rare financial product suddenly attracted a large number of pledges.
Anchor not only has a current income of close to 20%, but also issued a token called ANC to encourage everyone to deposit money on both sides, depositing UST on one side and LUNA coins as collateral on the other. LUNA is placed on the node, and you have to wait at least 21 days to get it back. Although you have to pay 30% interest when borrowing money, because the system provides subsidies, borrowing UST can also yield positive returns of up to dozens of percent.
crash process
The reason for the thunder is that Terra is deploying a new liquidity pool and plans to put several previous second-tier stablecoins into this pool to form a 4Crv pool (an exchange pool for 4 stablecoins in Curve), so that the liquidity of this pool will change. Thicker. Due to the need to prepare for the establishment of the 4Crv pool, US$150 million of UST liquidity was withdrawn from the UST-3Crv pool. At this time, the TVL of the UST-3Crv pool was around US$700 million. At this time, all it takes to drain the UST liquidity Around US$300 million.
Moreover, the crypto market was in a bear market during this period, rising against the trend without falling, and the mood of the Luna pool was already very fragile; 10 minutes later, a new address suddenly sold $84 million of UST, seriously affecting 3crv. It is equivalent to this US$700 million pool receiving a sell order close to US$100 million, and the selling pressure is not small. Although it did not cause a big slippage, it has attracted market attention.
In order to maintain the liquidity balance of the UST-3Crv pool, the project side withdrew another US$100 million of UST from the capital pool. At this time, some people began to exchange UST for USDT or DAI on the chain, and selling orders gradually formed, resulting in fewer and fewer other stablecoins other than UST.
When the proportion of other stable coins dropped to 95%, everyone began to be alert. Because as long as this ratio is a little more biased, according to Curve's pricing formula, the exchange rate will be much biased, and it is impossible to exchange at an exchange rate above 0.95. So the panic started when the exchange ratio dropped below 0.95, and gradually began to unravel. When it reached 0.9, many people started to sell out, because Anchor only had a 20% return rate after one year of depositing, and there was a 10-point difference in the exchange rate, so half a year's income was gone.
in conclusion
The collapse of LUNA and UST has brought us many enlightenments. First, the design of stablecoins needs to be more careful and comprehensively consider market risks. Secondly, regulators need to strengthen supervision of stablecoins to prevent similar incidents from happening again. Finally, investors should be more cautious, avoid blindly following the trend, and treat high-yield investment products rationally.
The future of stablecoins remains full of challenges, but also opportunities. Only continuous improvements in design, regulation, and investor education will enable stablecoins to play a greater role in future financial markets.