Striking unsecured stablecoins while hoping there won’t be a large influx of withdrawals – this is the financial model for Tether’s largest centralized stablecoin, $ 77 billion valued in USDT. Striking stablecoins backed by LUNA while hoping there won’t be a significant drop in the price of LUNA – this is the financial model of the largest decentralized stablecoin, $ 10 billion worth of l ‘UST of Terra.

UST, originally created to withstand up to 91% of LUNA’s decline in value (according to Terra’s white paper), has now deviated from its core goals of staying safe and strong. The reason? Terra governance prefers big returns on stable yield farming, not ecosystem stability.

~ 65% drop in LUNA could harm UST and the entire Terra ecosystem

The majority of the digital currency industry has had to contend with a price drop of around 90% during the bear market of 2018-2020, and there is a good probability of a similar drop in the near future. Will this be enough to destroy the entire Terra ecosystem? Absoutely.

Just two months ago, only US $ 3 billion was in circulation. However, newly developed platforms such as SPELL’s Magic Internet Money (MIM) have promoted the concept of taking greater risks to earn a high APY on stable farming, making Terra Mint more UST while hoping that LUNA will not. will not drop much.

Two months ago, UST’s total valuation was 12% of LUNA’s total market cap (indicating that UST would be fine as long as LUNA’s decline remained below 88%). Today, UST represents 36% of the total market capitalization of LUNA. Once LUNA starts to lose value and approaches UST’s market cap, there is a good chance that people will start to panic by selling their UST as well as LUNA, and therefore not just break their ankle. , but also the entire Terra ecosystem (for example, the Mirror Protocol, a platform built on Terra that trades synthetic stocks, has US $ 1 billion of UST locked down and could go bankrupt with the collapse of UST).

Interestingly, even Rune Christensen, the co-founder of MakerDAO, called UST and MIM “solid ponzis”:

Look, UST and MIM are solid ponzis and I respect that. You can definitely make a lot of money with them. But they are not built for resilience and they will go down to 0 once the market turns for real.

Now stop trying to rip off users looking for real stability to become your exit liquidity

– Rune (@RuneKek) January 4, 2022

The digital currency industry needs algorithmic stablecoins, but with a stable infrastructure

With Gary Gensler finally gaining full authority over the regulation of stablecoins, the United States Securities and Exchange Commission (SEC) can now regulate stablecoins like USDT and USDC as they see fit. In addition to regulating the companies behind stablecoins, this gives the SEC permission to blacklist any address that holds a stablecoin.

The possible damages of this authority can be viewed as follows: MakerDAO’s DAI token (set at $ 1) is primarily backed by USDC and ETH collateral. The SEC can simply order Center, the company behind the USDC, to use their blacklist (ethereum address) DAI’s USDC guarantees feature and blacklist. What happens next? Either MakerDAO’s governance allows for additional liquidations of ETH collateral to keep the anchor intact, or DAI loses its anchor.

Although algorithmic (or decentralized) stablecoins represent less than 2% of the market capitalization of the digital currency industry. It should be noted that in the event that the SEC cracks down on the industry, these algorithmic coins may play an important role in the future and possibly gain a much larger market share. However, algorithmic stablecoins like UST and MIM are simply the solution for greed, not industry. Industry needs stable parts that are oversized, not undersized.

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While algorithmic stablecoins are supposed to become a big part of the markets, it should be borne in mind that failures in such experiments (contract exploits, panic selling leading to a liquidity crunch, or just a bad algorithm) are quite common, and in particular the new algorithmic algorithm. Stable coins should be considered very risky.

In June 2021, stablecoin’s biggest algorithmic failure occurred due to TITAN’s liquidity crunch, which even hit Mark Cuban, the famous investor and billionaire. TITAN’s contract was exploited and all of its cash was drained from the Uniswap pool. As the algorithmic stablecoin IRON which was backed by TITAN went to zero. This may all be due to a contract feat, but it sends a strong message to the UST and Terra community; everything is good only as long as your stablecoin collateral has available cash.

The numbers discussed in this article, such as market caps, guarantee ratios, etc., were taken at the time of writing.

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