Bankless - UST: New Paradigm or Ticking Time Bomb? | Terra Bear vs. Bull
Primer: The Terra blockchain has experienced tremendous growth over the past year. Some of their detractors argued that UST, their native stablecoin, is a ticking time bomb. In this episode of Bankless, we have Jose Macedo of Delphi Digital presenting the bull case for the Terra blockchain and Jordi Alexander of Selini Capital presenting the bear case. Get an informed view on LUNA and UST from this episode.
The Representatives
Bull Case: Jose Macedo of Delphi Digital
Bear Case: Jordi Alexander of Selini Capital
Fundamental Properties Of Luna And UST
Terra is a Tendermint, Proof-of-Stake app chain
UST is a decentralized stablecoin
Can think of it as just ETH and DAI, as if Maker and MKR token does not exist. Hence, all value would accrue to ETH
Mechanism Design
Different from Maker — a debt-based stablecoin
UST is more similar to an algorithmic stablecoin
Mint UST by burning LUNA; Mint LUNA by burning UST
LUNA is the staking token, share token, and the governance token
Secures both the system’s consensus risk and the stablecoin’s financial/economic risk
How Does Value Get Balanced Between LUNA And UST?
Jose
When there’s excess demand for UST, UST will trade above $1
At that point, there’s incentives for people to burn LUNA to mint UST, sell it on the market, and collect the arbitrage
As supply of UST grows, there’s more demand for LUNA to be minted by burning UST to capture these arbitrage opportunities
LUNA captures a staking yield from fees generated on the network
Its Mechanism And Its Sustainability
Jordi
Don’t really see a problem until it becomes a huge problem
If there’s a rush for the exit, it will be very bad for the people holding
Jose
People have compared it to algorithmic stablecoins like ESD and DSD
However, ESD and DSD have never been stable. It traded at every price except a dollar
Currently, no algorithmic stablecoin has the track record that UST does
Why Is Jose Bullish On The Design?
Very bullish on LUNA. Most of his net worth is in LUNA and LUNA alts
Stablecoins are crypto’s killer apps
Centralized stablecoins is a temporary stopgap. The end game is decentralized stablecoins, which is a trillion dollar market/opportunity
UST is the largest decentralized stable coin by market cap and is the fastest growing one as well
Why Is Jordi Bearish On The Design?
He doesn’t want LUNA to fail, but sees a lot of potential issues down the road
There’s a lot of assumptions about the end game (i.e. a decentralized stablecoin):
Will the peg hold during volatility? This could come through a bear market or a reduction in demand once the yield in Anchor drops
Might see other L1s forking their idea and adding a tweak to it, drawing users away from it
What Are The Features Of UST That Made It Successful When Other Algo Stables Failed?
Jose
Most people treat algo stables as a mechanism problem design
It’s actually a utility and demand problem
Main thing that backs a stablecoin is demand for it
UST’s approach is to build an entire economy of use cases around UST, which creates that demand around it:
Mirror — allowed people to get exposure to synthetic assets
Anchor — gives you savings rate
Astroport — exchange it for different assets
Mars Protocol — a credit protocol
Spending UST in the real world
“It's difficult to have just a stablecoin. You need to build, you need to like verticalized and have your use cases on top of it.”
- Jose Macedo
Answering The Criticism That Algo Stables Are Inherently Unstable
Jose
It’s because most algo stables focus on ponzi incentives instead of utility
For an algo stable, it is important to build demand at the same time as you build the holder base
When there’s real utility, people would use the algo stable and not dump it even when the market turns
Jordi
The yield on Anchor is unsustainable. It’s just marketing expenditure
Eliciting Demand For UST With Anchor
Jordi
There are fundamental building blocks that the team built into Terra:
Chai — a payment system. It was a good experiment but it wasn’t follow through
Mirror Protocol — a synthetic asset platform. The assets are not stable. It was a good idea but it wasn’t executed well
Anchor — a killer savings app that gives 20% yield. Created huge demand for UST
The 20% yield is coming from the Luna Foundation Guard
They are treating it as a marketing spend to gain adoption
Does not think that it is effective in bringing retail people. Corporations end up taking all of the incentives
Will UST Ultimately Fail Like The Other Algo Stables?
Jordi
Thinks that it is 50/50
Luna has a better team. Do Kwon has amazing execution ability
Have strong players that are backing them
There are 2 risks:
Entire market goes down —> LUNA goes down —> people worry that there is not enough collateral in LUNA to absorb all the UST
If the yield on Anchor gets reduced, people will start to burn UST for LUNA, creating LUNA inflation and the basis for a death spiral
Anchor And Its Effect On The UST Peg
Jose
The 20% rate right now is unsustainable
Simulations show that the sustainable rate would be from 7 - 12%
A proposal was passed to make the rate more dynamic
The yield is marketing spend, but it has been massively successful because it has grown UST supply to 16 billion
UST is 80% backed by their Bitcoin reserves
Trusts UST:
Have been in the Curve 4pool, the most liquid pool in DeFi
Has all trading pairs
Is on exchanges on Layer 2s
Anchor is not a yield farming incentive program. They have to generate enough borrowing to pay depositors
Is The Purchase Of Bitcoin An Admission That The Model Is Not Sustainable?
Jose
Does not get that argument. It’s just a better design
The Bitcoin reserve backing it helps in the next step of adoption and trust and allows it to scale further
Jordi
Using Bitcoin as collateral to back UST is the right decision
It adds diversification and stability to the system
It also added Bitcoin risk to the system
By Bringing In Foreign Asset Reserves, How Is Terra Different From A Bank?
Doesn’t think that bringing in assets makes Terra a bank
Bringing Bitcoin to Terra in the most trustless way possible is an unsolved problem
There are various solutions:
Axelar
THORChain
None of them are ready for multiple billion dollars of Bitcoin
At this stage, Bitcoin is custodied by the Foundation itself
Does Jose See Any Concern That Terra Taps Into Bitcoin, An Asset That Is Outside Their Control?
Does not see a concern
DAI is backed by WBTC, which has very weak trust assumptions
DAI is also backed by USDC, which is centralized
USDC has blacklisted addresses before, making it vulnerable
Does It Require Trustless Bridges?
Need good trustless bridges
There are other solutions as well, such as synthetic assets at the layer 1 level with an Oracle
What Are The Risks Of A Depeg Event?
Reduction in UST demand due to:
Anchor having to reduce its yield
Another layer 1 designs the same mechanism and gives it a higher yield
Saw something similar recently with Waves. Had some issues with the same model
Thinks that they are buying time to go all out and integrate with as many places as they can
What Is Jose’s Response To The Depegging And Death Spiral Risk?
Important to concede that there’s a risk
Everything has risks
Even the over-collateralized design of DAI nearly blew up on Black Thursday
Decentralized stablecoins that use centralized collateral could have their collateral censored
Stablecoins have different sets of risks and trade-offs that they make
“And so the trade-off for me between DAI and UST, which are the two biggest decentralized stable coins, is that DAI prioritizes safety and protection from tail risk over growth, and UST prioritizes growth and capital efficiency over downside risk.”
- Jose Macedo
Demand for DAI does not grow the supply for DAI. It’s demand for leverage that grows the DAI supply
Hence, Maker ends up competing with other lending platforms and had to add centralized collateral like USDC
LUNA is backed by 3 things:
Demand for itself
Demand for UST
Bitcoin reserve
The question to ask is if 3 billion BTC is enough reserves to protect UST at 16 billion
Hard to model reflexivity
Stablecoins are a network effects business
There’s enough demand on secondary markets to bring LUNA above 50 - 75% in Bitcoin reserves right now
LUNA can grow its own reserve over time
In May 2021, there was a contraction in UST supply and coordinated FUD around LUNA. Buyers came in and the system survived
Saw people fleeing from LUNA to UST and going into Anchor during that period
Do Kwon And Key Man Risk
Jordi
Do Kwon is phenomenally intelligent and has been making very good decisions
Does not have a problem with it. Eventually, the ecosystem he is building is supposed to run itself
Thinks that the bigger issue is decentralizing from a brilliant founder and a powerful company to the community
Jose
Decentralizing too early is a problem
Especially true for stablecoins, which requires a lot of energy, integrations to be pushed, and products to be built at the beginning
Believes in progressive decentralization
Has worked with many founders in the space. Do Kwon is a good mix of a great engineer with a hustle vision
Where Is Terra On The Decentralization Spectrum?
Jose
Putting decentralization on a linear spectrum is difficult
Ethereum is decentralized, but its main stablecoin is completely centralized
From a technical perspective, Terra is centralized
Curve 4pool And Do Kwon’s Tweet That DAI Will Die
Jose
There’s a group of people on Twitter constantly making malformed arguments against UST
Maker has been arrogant and dismissive of UST
His interpretation is that it rubbed Do Kwon the wrong way
A coalition that includes Terra put up a 4pool on Curve consisting of UST, FRAX, USDC, and USDT
Will Ethereum DeFi Be Saturated With UST?
Jordi
Don’t think it’s that straightforward
Eventually, we will need something decentralized
Unsure about DAI’s prospects
Don’t think we are at the stage where UST outstrips USDC
Jose
Centralized stablecoins will not be a long-term solution
How Will UST Stand Up Against Centralization Vectors?
No one can seize assets or freeze balances on the Terra blockchain
There are other centralization vectors that you can target to make things difficult such as requiring KYC for UST integrations
The Significance Of The Adoption Of The 4pool In Lieu Of The 3pool On Curve
Jose
Is a massive win. It makes UST and FRAX the most liquid decentralized stablecoins on Curve
Maker’s response is that this development does not threaten the DAI peg
It’s not enough for stablecoins to be pegged. They need to grow in adoption, utility, and demand
Possibility Of UST Growing Too Big And Then Suddenly Collapsing?
Jordi
If it happens when everyone is already assuming that UST is money, a lot of people will get hurt
In that nightmare scenario, whales will swipe the Curve pool first and take the best price
Jose
Will be catastrophic for Terra
With the Curve 4pool, Ethereum will be affected
Doesn’t agree that retail will get screwed. It’s easier for retail to get out with lower slippage
Astroport is spinning up its own stablecoin pools. Can also exit this way
Everything in crypto has failure risk
Closing Statements
Jordi’s Bear Case For LUNA/UST
Demand drops
UST risks:
BTC bridge risk
Market risk — BTC might go down
Jose’s Bull Case For LUNA/UST
UST relies on being the reference stablecoin for DeFi as a whole
The misunderstanding, controversy, and the repetitiveness of the FUD makes him more bullish
Thinks that the peg FUD and Anchor Sustainability FUD is weak — he has explained the reasons for why he think that’s the case
Thinks that there’s stronger arguments against UST:
Key man risk
Technical aspect — Terra isn’t a particularly scalable layer 1
Decentralized stablecoins will become a multi-trillion dollar industry and UST is the fastest horse in that race
It’s becoming stronger with Bitcoin reserves
Has observed some of the smartest builders building on Terra
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