GSR: Analyzing the run on Terra and UST, what is the future of Terra?
Original title: "Anatomy of the Terra/UST Bank Run"
Originally Posted by Brian Rudick and Matt Kunke, GSR Strategists
Compilation of the original text: angelilu
GSR made a review and outlook on the Terra incident. For the full text, see "Anatomy of the Terra/UST bank run", this article is compiled and published by Foresight News authorized by GSR.
Two weeks ago, the TerraUSD (UST) stablecoin de-pegged from $1.00, causing Terra to crash and UST and LUNA alone lost over $40 billion.
Review the UST and LUNA crashes with data charts
UST initially came under moderate pressure on May 7, and its price traded between $0.99 and $1.00 until falling sharply on May 9. While the exact cause of the selling pressure is unclear, it appears to have started after Anchor withdrew $2 billion in UST, and hundreds of millions of dollars worth of UST selloffs occurred on stablecoin automated market maker Curve. In Curve's UST-3pool, $84 million in UST was exchanged for USDC, especially before Terraform Labs' planned 4pool deploymentWithdraw USTimage description
Figure 1: Curve UST-3pool May 2022 balance (unit: million) - data source: Dune Analytics, mhonkasalo, GSR (data is sampled every six hours)
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Figure 2: Anchor Protocol UST deposits in May 2022 (unit: billion) - data source: Anchor Protocol, GSR (the data is interpolated based on the daily balance on May 6 and May 8)
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Figure 3: LUNA Daily Supply Inflation
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Figure 4: Terra (LUNA) and TerraUSD (UST) prices - data sources Santiment, GSR
Analyze the mechanism behind Terra
While Terra's minting/burning stabilization mechanism appears to prevent decoupling, its fundamental mechanics limit its effectiveness. When conducting UST arbitrage through the on-chain market module, you must pay both the historically low gas fee and the variable spread fee, which can be considered as the slippage cost of trading on AMM, and may become quite important during stress periods, reducing arbitrage motive. Unlike traditional AMMs, where traders can swap one token from two token pools for another, Terra's marketplace module is similar to a virtual AMM, where one token is burned (instead of exchanged) to be minted Another token. Terra's virtual AMM uses a bonding curve based on a constant product formula to ensure that there is always some price liquidity between UST and LUNA, although one asset The price of an asset may become prohibitively high relative to another asset. This slippage/spread fee puts an effective cap on the amount that can be effectively traded on-chain, preventing market participants from profitably pegging UST arbitrage back during periods of extremely high arbitrage volume.
While this effective limit on the volume of arbitrage transactions may seem counterproductive, it exists to reduce the possibility of oracle manipulation. Ideally, on-chain liquidity would be slightly lower than off-chain liquidity, to prevent malicious actors from being able to manipulate price oracles off-chain on a smaller scale, while on-chain on a larger scale. The price oracle monetization of . The main parameters that determine the effective limit on mint/burn arbitrage volumes were recently updated in February to support an estimated value of approximately $293 million in LUNA minting capacity. However, only a fraction of UST looking to exit the market, based solely on Anchor outflows, prevents enough UST from being burned to bring its price back to $1 and forces most UST and LUNA volume to bypass the on-chain market Modules, occur in the secondary market. Additionally, this constraint slows expectations of UST's return to $1, likely leading to a bank run as the longer it remains decoupled, the more fear and sell-offs will occur.
To address this arbitrage bottleneck, Terra community members proposed Proposal 1164 on May 10 on Agora, Terra's research and governance forum. The proposal aims to quadruple LUNA minting capacity to roughly $1.2 billion to increase the rate at which UST is burned to help stabilize the peg. The proposal was supported by Do Kwon and generated enough votes to pass in just a few days, but it also required a one-week voting period, which was too long to ease the crisis caused by the panic. Immediate action is required. However, changing the minting/burning power will not necessarily prevent bank runs, as the arbitrage mechanism ultimately depends on the value of LUNA. Additionally, greater stabilization mechanism capacity would also lead to a faster inflation of the LUNA supply, which could exacerbate concerns about UST.
Terra's road ahead
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