The UST Bank-Run
One of the largest stablecoins in crypto has been broken
In this post, we will talk about:
The Terra stablecoin and de-pegging of UST
What is going on with UST and how it happened
What opportunities it presents to you as an investor
I usually post once a week on this newsletter, but I couldn’t help but write about the absolute mania happening in the crypto markets today. UST, or the Terra stablecoin, has de-pegged from $1 and is trading down about 20% as of right now.
This is big news for a few reasons:
Terra’s parent company controls two of the largest coins in crypto - the Terra stablecoin and the Luna governance token. Even right now, these two coins have market capitalizations of ~$14 billion and ~$11 billion, respectively. Just by sheer size, these are massive portions of the overall crypto market and ecosystem.
The de-peg brings in to question the viability of algorithmic stablecoins. A stablecoin backed by a governance token has the potential to create a truly decentralized currency. However, this situation raises concerns around whether that is even truly possible.
The Luna Foundation Guard recently purchased ~$2.5 billion in Bitcoin to backstop and support the UST peg in the case of a bank run, such as the one today. The volume of Bitcoin sold by Terra created downward pressure on Bitcoin’s price, and in turn, the rest of the crypto market
This brings in regulatory fire on crypto and stablecoins. There is no doubt that government agencies are getting ready to use UST as an example of why crypto is dangerous
Why did this happen?
If you remember from a previous post, Terra and Luna work in sync with each other to create the Terra ecosystem. The simple rule is that $1 of Luna can always be traded for 1 UST. This way, when UST price goes above or below the $1 peg, arbitragers naturally come in and fix the supply-demand.
If economics is not your thing, you can simply think of it like this: Luna token absorbs the volatility of UST and keeps it at $1. The supply of Luna is designed to expand and contract in response to volatility in UST.
Most of the UST that has been minted today sits inside the Anchor Protocol. Anchor is a decentralized finance protocol that pays out 20% for locking UST tokens. At one point, nearly 70% of all UST was locked inside of Anchor. This is good news when prices are stable, but it also creates a bank-run scenario when markets are extremely volatile.
If everyone runs to un-lock their UST from Anchor at the same time, it creates way too much pressure for arbitrage traders to come in and fill the peg. This is exactly what happened in the past couple of days.
What started the daisy-chain of events is still unknown. Some people are speculating that there was some form of coordinated attack on UST by a few large players - perhaps competitors or even large VC/hedge funds. What we do know is that nearly $285 million in UST was liquidated simultaneously from Curve and Binance.
This led to UST temporarily losing its peg. Panic spread almost instantly, magnified by the fact that crypto was already in a downtrend during this weekend. Deposits on Anchor fell steeply over the course of just 48 hours.
Luna Foundation Guard (LFG) responded to the fear by giving $1.5 billion in loans to OTC trading firms, in the form of both BTC and UST. The goal was to sell the Bitcoin and stabilize the price for now, and buy it back later.
The damage, though, was already done. In the following few hours, UST de-pegged even further and LFG was forced to sell the remaining Bitcoin in the treasury. As of now, the treasury is composed of 49% in Avalanche, with another 29% in Luna.
Where is the opportunity?
Before we get lost in the FUD, it is important to know that this is not the first time an algorithmic stablecoin has de-pegged. In fact, zooming out on the UST chart shows that Terra itself has lost its peg multiple times in its history.
We are hearing about it much more now because: i) crypto is more mainstream ii) Terra is more mainstream iii) Terra can impact price of other assets such as Bitcoin and Avalanche
The situation, however, is still the same as before. And each time, Terra bounced back even stronger.
If you believe LFG, Do Kwon (Founder of Terra), and the Terra community, that there will be a solution to the de-peg, then the opportunities are quite clear. At this point, you can buy Terra for $0.78 on the dollar - a clear arbitrage opportunity once the peg returns. Also, Luna is currently down ~50% due to expanding supply from UST redemption. If people’s confidence is restored, it will likely capture back a lot of the lost market cap.
If you fall on the other camp and believe that Terra is bound for failure, then it might be a good time to short Luna and Avalanche. If you are a holder of either of these coins already, then it might be a good idea to take some chips off the table. The redemption for AVAX is coming next if the death spiral continues.
Regardless of which camp you fall under, I would like to remind people of why we are here in the first place. If you are a crypto native, then you probably agree with the ethos behind decentralization.
UST, at the end of the day, is the largest decentralized stablecoin. I became a bull on Terra because it represents an opportunity to have true decentralized exchangeable currency. A win for Terra is a win for crypto - and building crypto for the masses will take some time.