Jun 6, 2022 - Economy

Why Terra's stablecoin fell apart as bitcoin fell: Report

Illustration of the Terra logo surrounded by a grid, a downward trend line, and various money-related symbols

Illustration: Sarah Grillo/Axios

"Over the three days from May 7 through May 9, Terra’s UST stablecoin deviated from its $1 peg in a sudden turn of events," a blog post last week from Jump Crypto begins.

Driving the news: Jump Crypto is a major market maker, meaning its business is taking the other side of as many trades as it possibly can. Its research team sat down to look at why the stablecoin terraUSD (UST) fell apart in early May.

  • Why it matters: Terra's collapse might go down in history as the cause of the current crypto bear market, but Jump's analysis makes it look more like a catalyst, the thing that triggered the larger downturn that had to happen one way or the other.

Zooming out: TerraUSD was a stablecoin that attempted to maintain a peg without collateral. It did so through a marriage with another token, luna, which was volatile.

  • Terra built in incentives for arbitrageurs to exchange terraUSD for luna as needed to maintain the peg.
  • However, if terraUSD started falling, this could kick off a death spiral, where both luna and terraUSD would fall at once.

Setting the scene: These days, as much trading happens in public, directly on blockchains (using decentralized exchanges or DEXs) as takes place on centralized exchanges. This means everyone can see sudden moves that might cause alarm.

  • Curve is a very important decentralized exchange designed specifically for trading stablecoins. It's the most important DEX in this story.
  • Curve had a pool of four stablecoins, UST, USDC (from Circle), DAI (from MakerDAO) and USDT (from Tether). Depositing any one would allow a user to withdraw an equal amount of any of the others (which works nicely because they should all have the same price).
  • DEX pools work best when there is lots of money in them, because that effectively means liquidity depth. Markets with lots of money moving are more stable.

Further, 75% of all the terra stablecoin was used for one thing: earning interest on Anchor, a savings protocol that paid almost 20% on UST deposits.

  • Though its interest was supposed to be paid by borrowers who used its deposits, few did. So those returns were heavily subsidized by the Terra ecosystem, using accumulated terraUSD from its treasury.
  • So the stablecoin was heavily dependent on one thing working, and it wasn't really working.
  • For what it's worth, Terra started as a new way for e-commerce firms in Asia to escape credit card fees, but that use case has long been forgotten.

What happened: So in Jump's telling, some very big players started pulling hundreds of millions of dollars out of that Curve pool we mentioned. This made the pool small, which made it easier to shake terraUSD's peg.

  • The peg inevitably shook. People started getting antsy. Meanwhile a couple very big terraUSD holders were pulling it out of Curve and lots of it was going onto Binance, creating a gush of liquidity that could have made its price wobble there too.
  • As things got shaky, the biggest depositors to Anchor started pulling their deposits out, putting tons more UST on the open market.

😬 Macroeconomic conditions were worsening. Jump's charts show large exits from Anchor coinciding with major dips in bitcoin price.

  • As major holders were running for the exits, some of the smallest holders were increasing their positions on Anchor, probably placing their faith in Terra's stewards to restore it.
  • They failed.

The bottom line: Success takes time, but disaster moves quickly.

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