Terra's Stablecoin Structure Unravels on a Wild Day
LUNA's Collapse May Consign UST to Long List of Failed Algo Stablecoins
By: Samuel Haig •Dive
The vulnerability in UST was plain to see from the outset. It was staring the market in the face.
The stablecoin’s promise to redeem 1 UST for $1 worth of LUNA invited trouble. It was a trade that required a leap of faith in LUNA’s resilience rather than the unambiguous support of hard reserves such as the dollar. And on May 9, that imbalance walloped investors when Terra’s algorithmic stablecoin tumbled 40% to $0.61.
While on Tuesday UST rebounded to about $0.90, the episode has delivered a blow to UST’s credibility, and perhaps that of algorithmic stablecoins in general. The drama punctuated a day that seemed to finally dispel any hope that investors could dodge a punishing bear market. What happens next with Terra, a DeFi darling for the last nine months, will be an important bellwether as in a market that’s lost confidence and is sown with panic.
UST’s slide was triggered when Terra’s native LUNA token cratered and could no longer support its sister token. The troubles also followed $500M worth of UST positions being sold via the Terra-based Anchor protocol on March 7, which appeared to shake confidence in LUNA and its broader ecosystem.
Terra previously promised that users could swap 1 UST for $1 worth of LUNA and vice-versa as a mechanism intended to maintain its peg. The design was supposed to iron out UST price volatility by incentivizing arbitrageurs to step in and trade the token should it move above or below the $1 level.
While the price of UST has bounced back 50% from the lows on the back of $2.4B in volume on Binance alone, questions remain as to the viability of UST’s design, and whether it may be destined to rest in the graveyard of failed stablecoin projects.
UST/USD. Source: CoinGecko.
The Basis stablecoin, previously known as Basecoin, was among the first algorithmic stablecoin experiments in crypto.
The project began in August 2017 with a $133M funding round in April 2018 from leading venture capitalists, including Andreessen Horowitz, Bain Capital Ventures, and Lightspeed Ventures. Basis planned to issue bond and share tokens that would be used to expand and contract the token’s supply and maintain its peg by incentivizing arbitrageurs to purchase or burn BAC depending on whether the stablecoin would be trading above or below $1.
But regulators stepped in and said the bond tokens were securities and demanded that the project collect detailed know-your-customer information and issue tokens solely to accredited investors.
“Unfortunately, having to apply US securities regulation to the system had a serious negative impact on our ability to launch Basis,” a notice on the Basis website states. “Although this isn’t the outcome any of us wanted, we knew going into this that we were fundamentally making a binary bet on a favorable regulatory landscape.”
Basis returned the capital it raised to investors, and did not launch the protocol.
Empty Set Dollar
Launched in 2020, Empty Set Dollar described itself as an algorithmic stablecoin that would act as the reserve currency for the DeFi sector. It sought to build on the design planned for Basis, and was launched by an anonymous team to minimize the threat posed by regulatory intervention.
The protocol sought to maintain its peg by issuing additional tokens when its price rose above $1 to increase supply and dilute the value of already circulating tokens. By contrast, it would incentivize users to burn their tokens in exchange for debt coupons when the price fell below $1 to create scarcity.
Although the price of ESD hovered near $1 during much of the fourth quarter of 2020, the token went into a death cycle in late December that year. ESD has consistently trended downwards since, last changing hands for just $0.005. It represents a 24-hour trading volume of just $26,310.
ESD/USD price. Source: CoinGecko.
In November 2020, the seeming success of ESD inspired two anonymous developers operating under the pseudonyms ‘Rick’ and ‘Morty’ to launch their own homage to Basis.
The pair launched Basis Cash that month, distributing BAC tokens to users that locked up other popular stablecoins including DAI, USDC, and SUSD. The project issued bonds and share tokens to control supply and incentivize the destruction of tokens when needed.
But Basis Cash only traded near $1 for roughly two weeks, with the token steadily crashing more than 90% during the first six months of 2021. The token was last exchanged for $0.008, with BAC driving just $33,645 in volume over the past day.
BAC/USD. Source: CoinGecko.
Ampleforth is another algorithmic stablecoin that took inspiration from Basis. Its peg is maintained by daily rebase events that adjust the supply of users’ balances in a bid to maintain its price at $1.
The protocol launched in mid-2019 and quickly appeared destined for failure when the price of AMPL steadily sank to levels below $0.40 just three months later. But its price recovered, with AMPL trading close to $1 from November 2019 until mid-February 2020.
AMPL experienced wild volatility in Q2 and Q3 of 2020 and since then it has continued to post dramatic swings between the roughly $2 and $0.70 range, seemingly undermining its utility as a stablecoin.
AMPL has been less volatile in 2021, trading within a range roughly 30% of either side of $1. It is currently worth $1.10 and represents daily volume of more than $2.2M.
AMPL/USD. Source: CoinGecko
The recent success of UST has inspired rival networks to launch their own stablecoins backed by holders who may redeem and burn the token in exchange for $1 worth of a native network token.
Neutrino USD (USDN) was launched on the Waves network in February 2022. But the protocol quickly became the subject of controversy, with a pseudonymous Twitter account alleging that the Neutrino team were pumping the value of WAVES and using the Vires money market protocol to prop up USDN’s market cap in early April.
A subsequent crash in the price of WAVES was accompanied by USDN quickly losing its peg. The token traded as low as $0.60 early last month, before largely recovering. But the token has failed to fully reclaim its peg, trading between $0.98 and $0.99 since.
USDN/USD. Source: CoinGecko
Other UST-inspired stablecoins include Tron’s USDD, which was launched last week, and Near’s USN, which went live at the end of April. However, the extreme volatility suffered by UST evidences that volatile market conditions can quickly result in these algorithmic stablecoins losing their peg.