Now that the whole 🌎 is watching, many in the space are doing a post-mortem
on what caused UST’s decoupling in the first place. 🕵️
To get your head around what really happened, it’s helpful to understand the different types of stablecoins and how they function.
Reminder: A stablecoin is digital currency that pegs to a “stable” asset like fiat currency, gold, or sometimes other cryptocurrencies in an attempt to stabilize the price and reduce volatility. 💡
High-level, you can place stablecoins into three categories:
- Those which are backed by reserves (most commonly fiat currency, often USD). 💵
- Collateralized stablecoins (i.e., MakerDAO’s Dai) which are pegged to other cryptocurrencies and tokenized dollars. Users are able to borrow against the value of their deposits and receive newly created tokens in exchange. 🤝
- Algorithmic stablecoins, which are undercollateralized and aim to peg a token to a target price using on-chain algorithms that increase or decrease supply. 🖥️
The tldr is that UST is an algorithmic stablecoin and uses an arbitrage incentive to maintain its peg to the dollar.
Both UST and Luna are part of the Terra Protocol and work in tandem. You need to mint UST before you can buy it, which is where Luna comes in.
The idea is that at any given time, a trader can burn 🔥 $1 worth of Luna to reduce supply and mint one UST. The opposite also works where they can exchange one UST for $1 worth of Luna. 💱
It’s worth noting you can always redeem one UST for $1 worth of Luna, even if UST is worth less than $1. For example, if UST is trading at $0.99, investors can buy it and redeem it for $1 of Luna, pocketing $0.01. When UST is trading at $1.01, they can also do the inverse-trade $1 of Luna for one UST, and pocket $0.01. 🧐
For UST to keep up demand and have utility, Anchor Protocol — a lending platform built on Terra’s blockchain — offers a whopping 20% APY
💰 for those who deposit UST on its platform. Prior to UST dropping off a cliff over the weekend, Anchor held about 75% of UST’s circulating supply (14 billion UST).
Today, it’s sitting at around 1.8 billion UST