Luna: The True Ponzinomics
Let’s start from the top — Terra. Terra is a public blockchain protocol deploying a suite of algorithmic decentralized stablecoins which…
Let’s start from the top — Terra. Terra is a public blockchain protocol deploying a suite of algorithmic decentralized stablecoins which underpin a thriving ecosystem that brings DeFi to the masses. The Terra blockchain is big and a lot of stuff to it.
But where the ponzi comes into play is: Luna, UST and Anchor Protocol Let’s dive into Luna & UST and see how they relate to each other. $UST is a decentralized algorithm stablecoin on the Terra ecosystem. Unlike other stable coins like $DAI $USDT..etc, UST has no collateral (US dollars, or crypto coins) backing it. However, UST relies on arbitrage and market incentives by working with Luna to maintain its peg. This is how UST maintains its peg to a dollar — There’s an on chain feature where you can swap Luna for UST vice versa at a fixed rate. In detail — you can burn 1$ worth of Luna and the protocol mints UST for you, vice versa. For IRL purposes or crypto purposes, the selling or buying of UST can push it above a $ or below a $.
However, Terra ecosystem relies on arbitrageurs to peg it back to a $. Possible scenarios:
1. UST is above peg: 1UST = 1.08$ 1Luna= 100$ An arbitrageur will buy 100$ Luna and burn it for 108$ UST in an on-chain swap, then sell the UST for a stable coin in an exchange. Profit
Oh well, the greedy and profit maxi arbitrageur will keep doing this and the UST sell pressure will de-peg UST from a $. Hence, decreasing the supply of Luna and increasing the supply of UST.
2. UST is below peg: 1UST = 0.94$ 1 Luna = 100$ Same way as scenario 1, an arbitrageur will buy 100UST for 94 dollar and buy 1 Luna and sell it to off chain exchanges to make 6$ profit. This will burn UST; hence, driving it back to peg.
Luna’s role is to absorb the volatility of UST. So what’s the problem
Well in the past many algorithmic stable coins have lost its peg and dug the earth
We remember iron finance? right right? Iron = UST; Titan = Luna
Here comes the possible scenarios for Luna-UST catastrophe
From UST-peg scenario 2 above we see that UST is below 1$ on off chain markets and if there’s a lot of selling pressure on UST and it’s hard to bring it to peg, that’s where catastrophe 1 comes in because arbitrageurs will do there best to bring it to peg by selling ust and buying Luna, then sell Luna on exchanges for profit. But, by doing this they are putting immense sell pressure on LUNA on off chain exchanges — the Luna order books on exchanges will have so much sell orders than buy orders. This will cause a huge dump on Luna. Thereby, causing panic in the terra eco, people will loose faith that UST can hold peg as they sell their UST to buy Luna so as to sell Luna and stay liquid. More catastrophic This goes on and on; you know the outcome.
Price of Luna is also an important issue here, if the price is too low it’ll affect its market cap and this can be an issue cos Luna MC < UST MC. Here’s why it’s an issue; the on chain swap promises that 1$ Luna = 1 UST burnt. However, if Luna MC < UST MC, burning UST won’t afford the $ worth of $LUNA as promised.
On Chain liquidity < Off chain Liquidity. Off chain liquidity should be slightly more than the off chain liquidity. Off chain exchanges like Binance, etc should have huge liquidity for Luna and UST pairs, cos if on chain order books are thin it’ll affect Luna’s price because of the normal arbitrage activity. Government crackdown on stable coins could cause the above and investors disbelief in the system.
Another part of the ponzi or let me say, the Real Ponzi. Ladies and gents I present to you Anchor Protocol. Anchor Protocol is a savings, lending and borrowing platform built on the Terra Blockchain. It offers lucrative passive income opportunities for depositors and provides borrowers easy access to collateral-backed stablecoin loans. It offers 20% yield on UST, one of the highest you’ll see in crypto. This will drive a huge demand for UST. We also have borrowers who deposit bLUNA in order to borrow more UST. Borrows also have to pay interest on their loans. Well, we can say they are paid to borrow cos these borrowers are rewarded with Anchor tokens. The anchor tokens they get is more than what they pay in interest. Ponzi! Anchor Protocol mints their own tokens to incentivize borrowing.
It’s unusual to see borrowers paid to borrow in the defi space. Here’s where the calamity lies;
Anchor has to give 20% yield to the borrowers. Anchor protocol has to pay all UST deposited by borrowers * 20% APY. It has to pay this cost to sustain itself
Now how does it generate its revenue to sustain itself. • Anchor Revenue comes from interest borrowers pay and staking rewards generated from all bLUNA & bETH deposited in the protocol as collateral. if revenue > cost, Anchor is on profit and this profit is put in its yield reserve.
However, if revenue < cost, they are on loss and have to go to yield reserve to clear their cost so as to pay borrowers their 20% APY.
This will drain the yield reserve fast — but the team can intervene by depositing huge amount of $ in reserve.
Will people wanna use Anchor when yields are lower? • Liquidations from Anchor is also an issue here. Remember people use Anchor to take out loans by depositing bLUNA to take out UST, and use that UST to buy LUNA. This is done over and over again to gain more leverage on their position. Well, this is fun when the price of $LUNA is on the rise. The issue is when $LUNA starts depreciating fast, most positions get liquidated. A 3rd party buys this bLUNA and sells it on exchanges thereby dumping Luna more.
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Please remember to do your research. None of this is financial advice.