Mirror and Nebula — A Tale of Two Protocols

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Coinmonks

5 min readFeb 26, 2022

What is Mirror Protocol?

Once upon a time, everybody criticized the dichotomy of the Terra ecosystem between Anchor Protocol and Mirror Protocol. Although the Total Value Locked (TVL) of the former far outweighed the latter, still Mirror Protocol was a project that actually delivered a product, people knew about, and people actually used.

The purpose of Mirror Protocol is to create on-chain synthetic assets (mAssets) which mimic the price behavior of the representative assets. mAssets keep their value through collateralization, as many collateralized stablecoins do. This could come in handy if investors which to take a position in off-chain assets without exchanging their $UST into $USD or any other fiat currencies — especially for Korean investors whose withdrawals are delayed by 24 hours by regulation.

However, Mirror Protocol has an intrinsic pegging mechanism that may hinder investors’ decisions.

You can see on the right side the “Premia” of mAssets, or the price difference s between oracle prices and Terraswap prices, easily range from -10% to 10%. The presence of Premia could be beneficial or adverse depending on the position you are willing to take, but overall Premia discourages trading mAssets.

For example, $mBTC is currently trading at $41,700, where as the oracle price is reported to be $39,300, a whooping 6% difference. If you wish to open an long exposure to $BTC through Mirror Protocol, you would be reluctant to witness the Premium disappear in the long run. Even if you wish to short $mBTC, you still never know whether the spread would tighten or widen, as there are prolonged Premia existing over all available mAssets.

Why such a phenomenon happens? We need look at the pegging mechanism of Mirror Protocol to find out.

Mirror Protocol Docs writes that it has 3 layers of price pegging:

Minting Liquidation :
Let’s say $AAPL = $200 = $mAAPL at t = 0. Our dear Julie opened a $mAAPL short position at t = 0 as well, which means she deposited $UST, minted $mAAPL, and posted it on the market.
1 $mAAPL is backed by 400 $UST to keep its value with the Minimum Collateral Ratio (MCR) of 150%.
At t = 1, $AAPL suddenly rises to $300, but $mAAPL is still trading at $200. Now the oracle reports $300, so the required collateral for a $mAAPL also rises to $450.
The provider of $mAAPL did not fill up her $UST collateral, so her $UST is sold to buy $mAAPL from the market, which in turn appreciates the $mAAPL price to $300.
Arbitrageurs
When $AAPL = $300 and $mAAPL = $200 at t = 1, arbitrageurs may buy $mAAPL under the assumption that $mAAPL will regain its peg through 1.
Governance
Governance can change the MCR so that liquidation threshold is much tighter, thus maintaining a tighter peg.

Mirror Protocol states clearly in its Docs that mAssets are soft-pegged to oracle price feeds, so its price deviations are intentional features rather than erroneous flaws. Docs writes that ‘theoretically a mAsset can trade at 50% premium if the MCR is set to 150%.’

I personally do not know why the peg was designed in this way, but anyway it at least discouraged me to open a mAsset position before.

What is Nebula Protocol?

Nebula Protocol is a protocol on the Terra network that serves to create on-chain index funds. Nebula Protocol released its Docs on Feb 27th.

Nebula Protocol removes the ‘third man’ who is essential in TradFi index funds; Nebula index funds, which are called Clusters, has flexible parameters and no need for active management to maintain allocations.

To open Clusters, the community discuss at the Nebula Forum on the investment strategy, vote for the strategy, and if the strategy passes the poll then it is put to operation.

Clusters can designate target oracles that updates the asset allocation for Clusters. To put simply, target oracles are the active managers of enhanced index funds in TradFi. The asset allocation accepts a broad spectrum of strategies — it could be a simple 5:5 BTC:LUNA, or a complex trading strategy that requires constant rebalancing through twenty assets.

Clusters mint Cluster Tokens (CT) which represent shares of Clusters. Of course, CTs are CW20 tokens tradable in Astroport, so possibly the prices of CTs can deviate from the Net Asset Value (NAV) of the Cluster.

In that case, Nebula Protocol incentivizes trading activities that helps to regain the “peg”, and penalizes the opposite.

Let’s say Cluster A has a NAV of $100, and it minted 100 CTs at t = 0.
At t = 1, Cluster A has grown to $110, but CTs are still trading at $1.
Julie can take her CT, redeem it for underlying assets in Cluster A which worth $1.1, sell them on the market, earning a $0.1 profit.
Since she is arbitraging to keep the peg, Nebula Protocol will reward her with discounts and $NEB to incentivize active arbitraging activities.

Mirror-Nebula Complementation

Now imagine if we open a Nebula Cluster that manages an index fund comprising mAssets, with the target oracle set to off-chain markets.

In other words, if the real world has two companies, $AAPL and $COIN, each with 50% equity market share, the Cluster would buy $mAAPL and $mCOIN at 5:5 ratio and try to maintain the ratio throughout its lifespan.

$mAAPL and $mCOIN can trade above of below its fair price by design, but if $mAAPL:$mCOIN is trading at 6:4 ratio, Nebula Cluster would foment a selling pressure on $mAAPL and buying pressure on $mCOIN to have its NAV composition 5:5 — helping to regain the mAsset pegs.

With mAssets trading closer to pegs, investors would be more confident in leveraging Mirror to long/short assets that are not available on the Terra network.

Although Nebula Protocol has just released its Docs and its App has still a long way to go, Mirror-Nebula is a fun thought experiment.

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Mirror and Nebula — A Tale of Two Protocols

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Written by HODL_GAP