TERRAble algorithmic stablecoins and how The Standard Protocol is very different.
Many were shocked by the total destruction of LUNA (a top 10 crypto project) and its stablecoin UST totally collapsing, losing 14 Billion dollars. With LUNA going into hyperinflation by 6.5 TRILLION units in one day alone.
That’s a 10,000x increase in supply, something that would make Venezuela blush.
The Standard is being created by a team that saw this catastrophe coming and talked about it many times. “Stablecoins are one of the most important aspects of the crypto space, but it’s run by a bunch of cowboys and scammers!” Says Joshua Scigala, Co-Founder of The Standard and Vaultoro, one of the oldest exchanges in the industry.
He goes on to say “We created Vaultoro after seeing the incompetence and transparency of MtGOX, the first bitcoin exchange in the world after it fully collapsed. We have been working on The Standard for a year now because we could see that LUNA Terra, USDT, WAVES and many other stablecoin solutions were built terribly if there were not outright scams.
This post will explain what happened with Luna and what makes The Standard totally different and worthy of becoming the ultimate stablecoin solution.
HOW AND WHY DID LUNA FAIL?
LUNA TERRA was the Layer 1 blockchain, and its goal was to host decentralized algorithmic stable coins that were core to its blockchain ecosystem. A lot is going on in the TERRA world, but I’m going to focus on why its core components failed in a new type of Ponzi / snowball scheme.
There are three relevant pieces to this story,
LUNA, UST, and ANCHOR protocol.
Let’s start with the system’s most fundamental components, Luna and UST, and see how they interact. UST was meant to be a stable cryptocurrency with a USD $ 1 peg. But what sets UST apart is that they have nothing to back up that one dollar price. To put it another way, there is no collateral or value. UST relied purely on arbitrage and market incentives to keep its peg. We at The Standard, on the other hand, have bitcoin, ethereum and or tokenized gold as collateral backing every stablecoin issued.
Here’s how LUNA (which is also the TERRA ecosystem’s native token) and UST worked together to keep the UST close to 1 Dollar.
TERRA provided an on-chain swap option where you could exchange Luna for UST and vice versa at a set rate. You could burn $1 worth of Luna (at current market value), and the protocol will create one UST for you. Or you can go the other way and burn one UST, and the protocol mints $1 worth of Luna for you. NOTE decentralized oracles sourced the price of LUNA and fed the smart contract that current data.
This is crucial to understanding what happened because you have two choices. If you wanted UST, you could buy it on an outside exchange or burn and mint it yourself. People chose the most cost-effective choice for them at any given time because sometimes UST was over $1 on exchanges, and other times it was under $1, but you may be wondering why that even happens?
It all boils down to UST demand fluctuating. Assume you wish to use some dApps in the TERRA ecosystem, and UST was required. Well, you would exchange some other crypto for it. The price of UST rises as a result of this buying pressure. As a result, it may exceed $1.
On the other hand, if you have a lot of UST but want to trade it for another crypto, then that selling pressure will push the price of UST below $1. When either of these scenarios occurs, the TERRA system needed arbitrageurs to return the price of UST to $1. Let’s go over each scenario step by step because that will allow us to appreciate better why we at TheStandard.io saw this as a ridiculous system that would and did eventually fail spectacularly.
Scenario 1: UST exceeding $1.
Let’s suppose UST was worth $1 and 5 cents on the open market. As an arbitrager, here’s how to generate money. Assume Luna costs $100, and you have one Luna. So you send it to the TERRA swap smart contract, which burns it, mints 100 UST, and sends it to your wallet. This is all on-chain. Then you trade your 100 UST for $105 worth of other common coins. Because UST is currently selling at $1 and 5 cents, and if you have a hundred of them, you’ve made $5 in low-risk profit.
Now you and others will repeat this process until your selling pressure forces UST back down to $1. Pretty cool, right?
One thing that you might realize is that by burning LUNA and having the system create new UST, this arbitrage process increased the supply of UST while decreasing the supply of LUNA.
Scenario 2: UST is under $1.
In the second scenario, we look at what happened when UST was less than $1, say 95 cents. In that situation, you can perform a similar arbitrage by purchasing UST (creating demand) and burning it for $1 in LUNA, then selling that LUNA on other markets to lock in your winnings.
Because you and other arbitrageurs are buying UST before burning them to net LUNA, you drive the price of UST back to $1. This process also reduces the supply of UST while increasing the supply of LUNA. The system dynamically adjusted the supply of UST and LUNA and relied on economic incentives to bring the price of UST back to its desired peg. This is why UST falls under the category of an algorithmic stable coin.
We at The Standard are not building an algorithmic stablecoin but rather a decentralized asset-backed stablecoin protocol. This is because all stablecoins minted are overly backed by rare assets similar to MAKER DAO protocol. On a side note, DAI was one of the few stablecoins that did not lose their peg during this whole debacle. Even centralized stablecoins like TETHER USD lost their peg for a while. The Standard also improves many things over the MAKER DAO, but that is for another article.
So Luna’s role is essential to absorb UST price volatility. This is all pretty straightforward, right? So, what’s the issue? Well, historically, algorithmic stablecoins have been very fragile, and actually, all of them have permanently lost their pegs. Simply check out Ampleforth, BASIS, WAVES, IRON FINANCE or Dan Larimer’s BITSHARES BITUSD, just to name a few. If you look at any of their charts, you’d think they were for regular cryptos, but they’re actually supposed to be stable around $1.
But I digress. If there is a lot of selling pressure on UST and it’s difficult to bring it back to $1, then what happens?
People will start that arbitrage process where they buy UST to burn and mint new LUNA and then sell that LUNA to make a profit.
However, by doing so, they are putting enormous sell pressure on the available LUNA order books bringing the price of LUNA down. Remember, you always get 1 dollar worth of LUNA, so if the price of LUNA drops, the system has to mint more of it to match one dollar. Do you see where this is going? To add to the inflation, if the LUNA order books become thin and no one wants to buy LUNA, then the price falls further, which causes even more LUNA to be minted. Downward spiral, anyone?
Remember, there is no limit on how many LUNA can be minted so if you follow this to its logical conclusion, you get hyperinflation of LUNA. This absolutely destroys the confidence in the underlying value of UST, which also starts to drop in value.
The price of Luna was extremely important to the system’s stability because when the LUNA market cap fell below that of UST, that meant that burning every UST available could no longer provide the market with the promised equivalent dollar value in LUNA no matter how many units they minted.
Another critical factor was the amount of liquidity on-chain with a swap feature versus off-chain on exchanges. TERRA needed on-chain liquidity to be less than off-chain liquidity. This means more liquidity for Luna and UST on exchanges like Binance and DEX’s like uni swap. Why? Because once outside order books got too thin, normal arbitrage selling started to have a larger and larger impact on LUNA’s price, leading to the hyperinflationary death spiral we saw.
THE PONZI PART
Let’s talk about Anchor protocol. ANCHOR was at the heart of the TERRA economy and played a huge part in the Ponzi mechanics we saw play out and come to its eventual conclusion of everything falling to pretty much zero.
ANCHOR was the main borrowing/lending protocol for the TERRA ecosystem. They stood out by offering a staggering 19.5% yield on people’s UST. This was an offer most people could not walk past, and they didn’t! Roughly 70% of all UST in circulation was sitting in Anchor collecting that crazy good yield. That was billions of dollars locked up!
There were two sides: Anchor, borrowers and lenders. The borrowers who deposited collateral, such as LUNA in order to borrow more UST go back around to lend and earn 19.5%! Borrowers got paid in Anchor tokens, so why would you not borrow UST to then lend and earn?
But what if Anchor stops offering such a high yield? Well, like anything in DeFi, the market is fickle and would pull out its liquidity; the main use case for UST would falter.
Well, this is exactly what happened.
UST actually could have had many other use cases, but they were obsessed with massive fake instant growth, and so all the use cases were about this one yield farming opportunity on Anchor.
As people withdrew capital from Anchor, the demand for UST disappeared, and the peg dipped. The peg dipping drove many arbitrageurs to Burn UST for LUNA, but LUNA also had less interest because the yield in Anchor was drying up. So LUNA started to see massive inflation with no one wanting it and many minting it to get out of UST.
THEREIN LAYS THE START OF THE DOWNWARD DEATH SPIRAL OF LUNA UST.
Why is The Standard different?
Our name, The Standard, comes from The Gold Standard, a system where there is physical gold backing every dollar in circulation. This is what determines the currency’s value.
In The Gold Standard, the state held the backing asset. We are flipping this on its head. We don’t need a government to start a gold standard. Us gold bugs gave up years ago and just started to stack gold personally. In fact, there is around 5 trillion dollars in private gold holdings sitting in vaulting facilities around the world.
So we enable people holding gold to tokenize it and deposit that into a smart vault. They can then generate up to 85% of that value in a Standard stablecoin like sUSD or sEURO. People can also use bitcoin and Ethereum to mint stablecoins, and the DAO will be adding other assets over time.
While UST was backed by fluff, by a governance token that had no value outside ANCHOR, The Standard has real assets that it can’t simply mint or burn into and out of existence.
The Standard’s protocol backs its stablecoins with real value. It makes sure it is always overcollateralized, meaning there will always be fewer stablecoins in the market than the assets backing them.
Other differences are the smart vault features. You can set the protocol to exchange any assets you have locked as collateral for gold, a less volatile asset if the value of the volatile asset starts sinking. This will avoid liquidations and keep people happy. If you do not have that option set and your assets are heading to liquidation, you can choose to be notified, so you can buy the stable coin back off the market, burn it and get your collateral back.
We built Vaultoro, the first bitcoin / physical gold exchange, back in 2014 to fix the issues of intransparent and insecure exchanges in the bitcoin space. We are now building the ultimate decentralized stablecoin solution for the world. Join us at TheStandard.io or give us feedback on Discord or Telegram
