Securitize Capital Market Commentary — May 10th, 2022
Macro
Double-digit declines in equity markets is not surprising following last week’s FOMC meeting and valuation dislocations. The fixed income credit market has been pricing duration risk and volatility for some time, yet we believe that the full effects of quantitative tightening are not yet reflected. The risk premium has somewhat widened between CDX Investment Grade and High Yield in 2022, however, it was not nearly as severe as what we had seen during the pandemic (Exhibit 1). We expect that illiquidity premiums in credit will be wider as corporate growth slows due to recessionary pressures, leading to wider spreads between investment grade and high yield credits. Inflation is anticipated to remain above the Fed’s target despite recent rate hikes. The Fed is in ‘wait-and-watch’ mode, favoring a bear-steepening trade and risk-off posture for the remainder of 2022. In the near term, we expect a short cover rally in risk assets with shallow liquidity and sluggish momentum that will offer range-bound trading opportunities. Highly risk-averse investors may want to stay in cash!
Exhibit 1: CDX Investment Grade vs. High Yield Spreads
Source: Bloomberg as of May 10, 2022.
Cryptoland
Spot:
FOMC-driven market turmoil became elevated in the crypto market and the talk of the week is TerraUSD (UST) de-pegging, subsequently trading at slightly below $1 last weekend. The Curve exchange liquidity pool was de-pegged after $150 million of UST was depleted by Terraform Labs, while another wallet bridged $84 million of UST to Ethereum for liquidation. We saw a full assault on UST as the stablecoin dipped to $0.52, and LUNA, its sister token against which it trades to ensure stability, traded at $2.34, at the time of publication. The cascading events of UST dropping below its $1 peg highlighted ‘wrong-way’ risk. Falling BTC price weakened the UST peg, and triggered further decline. BTC reserve would have to be liquidated in order to defend the peg resulting in selling pressures that led to further BTC price compression, creating a downward spiral. UST de-pegging drew the attention of U.S. regulators attention. In a hearing on Tuesday before Congress, Yellen commented that stablecoin “is a rapidly growing product and there are rapidly growing risks,” and highlighted the importance of stablecoin regulation.
Exhibit 2: TerraUSD (UST) Price as of May 10, 2022
Source: Bloomberg as of May 10, 2022
Under the current risk-off market environment, cash (stablecoin) is king, but not all stablecoins are created equal. At Securitize Capital, we chose USD Coin (USDC) for our yield-generating fund as USDC is fully backed by cash, cash-equivalents, and short-duration U.S. Treasuries, and is therefore always redeemable 1:1 for U.S. dollars.
BTC reached a critical 30,000 and momentum indicators show it is oversold. Investors are advised to consider recent strong correlations to technology stocks before jumping on the bandwagon to ride the volatility.
Exhibit 3: Bitcoin Spot Price
Source: Bloomberg as of May 10, 2022
Options:
Front Calendar bitcoin and Ether options were priced to high implied volatility. Ether volatility was at 100% again. Cost-less butterflies expressed risk/reward better than Delta One implementation.
Spotlight: Anchor-LUNA-Terra
Anchor Protocol is a decentralized lending and borrowing platform on the Terra blockchain that enables fast withdrawals and pays depositors a low-volatility interest rate. Anchor (ANK) launched in March 2021 and went live as the largest Decentralized Application (DApp), attracting investors by offering a 20% APY on TerraUSD (UST), an algorithmic stablecoin.
UST relies on another token, LUNA, to keep its price of a dollar by way of a set of on-chain mint-burn mechanisms. LUNA can be burned to mint UST; and UST can be burned to mint LUNA. If UST is over the $1 peg, LUNA holders are incentivized to burn their LUNA for a quick profit in UST. In theory, the increase in the supply of UST should bring the UST peg back to $1 (see chart below), and vice versa. Total Value Locked (TVL) on Anchor Protocol is approximately $12 billion, more than half of the UST total supply.
Source:https://research.thetie.io/the-terra-triforce-rise-of-the-lunatics/
Borrowers can deposit bLUNA or bETH and are able to borrow UST up to 80% of what they have deposited for a 13% interest rate. If a borrower ever exceeds the 80% cap, the deposit will be liquidated. All interests earned on bonded ETH/LUNA (in addition to the borrower’s interest) goes to ANK Protocol. As such, all lenders are required to lend for a minimum of 21 days. Currently, the Anchor Protocol holds $14 billion from lenders and $3 billion from borrowers, giving the protocol $17 billion in interest-bearing assets. ‘Anchor Rate’ is a break-even funding rate of the protocol (i.e., the rate at which the protocol can offer to lenders while still staying in business). It varies month-to-month depending on the UST peg with a 1.5% monthly range and a 15% floor. Any excess funds after lenders are paid is placed in the yield reserve, which can buy its own protocol token ‘ANC’.
The Anchor rate is being set higher than equilibrium and as such, its yield reserve has lost more than 43% of its value in the last 30 days. At the current rate, the reserve will be fully drained in less than two months. Due to ANK being such an integral part of the Terra blockchain, depleting yield reserves have the potential to take down the entire blockchain. The last time this happened, the Luna Foundation Guard (LFG) stepped in and provided ANK with a $450 million bailout. Anchor reserves have been funded from Terraform Labs and have had several cash injections from the past. If reserves fully dry up, ANC plans to increase incentives for borrowers so that they have more money coming in than going out. In February of this year, ANK’s reserves were sitting at 503 million, and only three months later their reserves were at 194 million. This rapid downturn is happening as the crypto market has shredded 20% of its value since the start of 2022. During crypto market downturns, borrowers are less incentivized to use ANK, causing lenders to exceed the amount of collateral that has been put up by borrowers. There is currently a 350% difference between lenders and borrowers, which is putting a lot of strain on the protocol.
The Luna Foundation Guard now holds 42,530 Bitcoin as reserves to defend the UST peg when it dips below $1. In response to UST trading below its $1 peg, the LFG announced that they will be lending out $750 million worth of UST to OTC trading firms in order to help reestablish the UST peg. LFG also withdrew 37,000 Bitcoin and tweeted that they will be using this Bitcoin to buy UST. The resulting concern is that the biggest accumulator of Bitcoin has suddenly become the biggest seller of BTC. We continue to closely monitor crypto market conditions and the effects of this historic selloff.
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