What Happened to Me… The Story of UST
In this article, I will try to tell the story of the stable currency UST, which came out of the Terra network last weekend.
The stable coin UST, which was issued by the Terra blockchain, which is trying to specialize in payment systems, lost its anchor to the US dollar due to the attacks at the end of last week. Let's first look at the concept of what is stable money, and then look for an answer to what was the main problem in UST.
What are stable coins? USDT, USDC, DAI… What's the difference?
Stable money means money that is anchored to a certain nominal value. What we call fiat money, is the money issued by the central banks. As a matter of fact, almost all of the stable money market consists of the US Dollar.
Stable currencies are important because they provide the liquidity that the decentralized world needs. They also function as a safe haven for investors to park their money in the volatile world of basic cryptocurrencies such as BTC and ETH. On the other hand, they provide a good income door in return for this liquidity they make use of.
The biggest group among stable currencies are those that have a real money behind them, led by USDT, USDC and BUSD. What does that mean? Paxos, which mediates the printing of BUSD, deposits that many dollars in banks in the USA for every BUSD it prints. USDC similarly keeps most of its money in cash in the bank (there is also a small portion of US bonds). The situation of USDT is mixed. They hold corporate bonds in exchange for the coins printed, so 100% there is no money in the bank. Let's keep in mind that all of these coins are centralized structures.
In addition to this group, there are also cryptocurrencies, not fiat money, behind this group, which is led by DAI. In DAI, run by a decentralized structure called MakerDAO, behind every coin printed there is an amount of cryptocurrencies far more than the value of DAI.
UST, which is the subject of our article, follows a different path than the two groups above. Let's take a look at it now:
What about UST?
UST is an algorithmic stablecoin. What does that mean? It doesn't have a fiat currency behind it or any more cryptocurrency than minted like DAI. Instead, there is LUNA, the core coin of the one-on-one Terra ecosystem.
Briefly, the system works as follows: Whoever wants to receive UST sends his LUNA. Is a LUNA worth 100 dollars sent, in return 100 UST is printed and the received LUNA is also burned. Want to exchange your UST the day after tomorrow? A $100 LUNA is printed and the UST you sent is burned.
Why is UST needed?
There are so many stable currencies in the market. Also, is UST necessary? Because Terra is a blockchain specialized in payments, it needs a currency that is liquid and flexible according to the needs of its system. If USDC wanted to use a currency like USDT, it would have to make a payment for it. For UST, there is no need to make such a payment. If there is demand, LUNA can print it. What if people accept this system and use UST? But why would people use it?
In theory, if you believe the Terra system will grow and become widespread in the future, you can adopt UST to use applications built on it. However, this was not the case initially. We entered the egg chicken spiral. So what to do? It should expand the use of UST with the timely incentive system implemented by DeFi.
The Terra system used a mouthwatering incentive to popularize the use of UST. With a loan application called the Anchor protocol, it started to give a full 20% interest on USTs deposited into the system. We are talking about a world where dollar interest rates are close to 0 in the USA. 20% interest is incredible!
As a matter of fact, the desired came true, and in about 18 months since its first establishment, the total of IHRs in the market has reached 18 billion USD.
What happened recently?
UST actually survived a great disaster before it came to this day. In May 2021, its value dropped to $0.96 for a while, but then recovered.
This expansion of the UST has also benefited LUNA in a sense. People had to give LUNA to get UST with 20% interest expectation. This has created a serious demand for LUNA. On the other hand, the LUNA's supply was decreasing as the given LUNAs were burned. As a result of all this, the value of LUNA rose from $1 to $112 at the beginning of April.
Well, it's a spiral. It goes well upwards; what if it's reversed? If people one day lose their trust in UST and give their money back, they will be given a LUNA in return, and they will sell their LUNA on the market and the LUNA price will drop.
Here, the founders of Terra applied a method that central banks have used for centuries to break this cycle. Central banks keep ammunition in their warehouses to defend the value of their currency. These are usually other countries' currencies and mostly gold. What's gold in the crypto world? BTC of course. Terra, too, announced that he will receive $10 billion worth of BTC to hold in the UST treasury. In the meantime, he bought a BTC worth approximately 3 billion USD and put it in the safe.
It seems that this move was not enough. In the crypto market, which experienced a decline after the FED's statements last week, there were serious UST sales towards the end of the week. After this, UST lost its anchor to the US Dollar. (You are reading the details of the event in the news. We do not go into the details in order not to prolong the article, but those who wish can follow what happened from the updated link). At the time of this writing, its value was still around US$0.80.
The point is trust
It should be said that stable currencies are the cornerstone of decentralized finance. For this reason, the trust it will give to the users is very, very important. The investor already takes enough risk with the expectation of a certain return in the applications he uses. While doing this, he thinks that the stable money he owns will return to him as the same amount of value the day after tomorrow.
In currencies such as BUSD and USDC, this trust comes with the motto "Look, there is money in the bank behind the printed token". USDT has its shortcomings in this sense, but with the advantage of being the first, it has become the defacto currency of centralized exchanges. There is a lot of collateral behind your DAI pattern (which makes it a bit risky, of course, especially in case of spikes), as the collateral is cryptocurrency.
UST is at a different point as an algorithmic currency.
First of all, it is worth noting that algorithmic stablecoins are still experimental. Many legacy applications (like Basis) have not been successful. Although Ampleforth is still around US$ 1, it could not reach wide audiences with a market value of around US$ 100 million.
The success of these currencies in the long run depends on their acceptance by the broad masses. To be used in payments, applications must accept this money. Therefore, first of all, the use of Terra system should increase or UST should be opened to other blockchains (we know that Terra has agreements with Avalanche and Evmos on usage). You can increase the printing of UST by paying high interest, but if people take this money and invest it in interest, it does not mean that it is used.
In the short term, for the success we mentioned above to come, there must be full confidence in LUNA. Printing money with high interest rates is not a sustainable method. You will make annual interest payments of $3.6 billion for the $18 billion in the Anchor protocol. You will effectively counter this by pressing LUNA.
Trying to grow with hormones with high interest rates in the short term is a very risky move. On top of that, the lack of transparency of the measures taken by Terra against the attacks on the UST further damaged the trust. Terra's response to the massive withdrawal of UST from the market was to give about 1.5 billion USD to large trading groups, which we call the OTC desk, and tell them to 'protect the UST'. It is not clear exactly how this money was used (OTC desks spend on centralized exchanges, not on the blockchain, so it cannot be tracked). Where there is no transparency, rumor and fear begin. This is one reason why it happened.
The main path that players of decentralized systems should follow should be decentralization. Initially it may be permissible for the founding team to be centralized during the growth phase, but this must change in the long run. Decentralization requires that the decision mechanisms be transparent and that all transactions of the system can be followed on the blockchain. In this sense, the founding team of UST is both a central team and the measures they take are not transparent. Making some of your money in BTC does not make you decentralized. Let's see if the team can regain trust and bring UST back to the $1 level. It looks pretty tough.