Learn why LUNA is in a death spiral in one article


Learn why LUNA is in a death spiral in one article


Learn why LUNA is in a death spiral in one article


In the overall downward movement of the crypto market, UST was severely de-anchored and LUNA's 24-hour drop of over 60% became a typical event of market concern.

coingecko data shows that TerraUSD today is trading at $0.742449 with 24 hour volume of 5,539,349,043. UST price dropped 25.5% in the last 24 hours. it has a circulating supply of 18 billion UST coins and a total supply of 18.4 billion. Also according to the ticker, LUNA is down over 60% in 24 hours.

In response, Do Kwon, founder of Terraform Labs, which provides support for the Terra blockchain, is taking steps to shore up its algorithmic stablecoin. the Luna Foundation Guard, an association created to support decentralized tokens and the Terra blockchain, said that as the cryptocurrency market continues to plummet and TerraUSD falls below $1 USD, it will issue about $1.5 billion worth of Bitcoin and TerraUSD loans to help strengthen the peg to TerraUSD.

So what is the mechanism inherent in the severe de-anchoring of the UST, the rapid fall of LUNA into a death spiral, and the rescue by the Luna Foundation Guard Association?

Terra's ecological composition

Simply put, Terra (token Luna) is a public chain ecosystem built around a stablecoin, whose business goals can be summarized into two points: to drive the prosperity of Terra public chain and provide a platform for open finance and other applications to develop the Web3 economy; to drive the mass adoption of its stablecoin represented by UST (an algorithmic stablecoin), replacing centralized USDT, USDC and other stable coins. Terra has also successfully emerged from the circle through the stablecoin+public chain model.

Terra has deeply bound its stable coin to the public chain business, specifically, it is reflected in: Terra's public chain ecology provides the initial application scenario for the stable coin, solving the biggest problem of stable coin, namely cold start. stable coins such as UST need to destroy Terra's token Luna to be minted, the larger the stable coin issuance, the larger the Luna deflation scale, the smaller the total supply. Conversely when USTs are redeemed in reverse for Luna, the supply of Luna will increase.

It follows that the purpose of Luna is to absorb the volatility of USTs. For each UST minted, Luna must be burned to the value of $1. Luna maintains the anchoring of the UST to the USD through the arbitrage and minting tax mechanisms. If $ UST price is > 1$, there is an opportunity to destroy $Luna , mint $ UST and take the difference with the peg as profit. If UST is < 1$, you can burn $UST for $Luna to restore the peg. Buy 1 UST at less than $1 and get $1 worth of Luna. then sell $Luna for profit. As the demand for $UST grows, Luna gets burned day by day.

What is the source of demand for UST?

Anchor Protocol (hereafter referred to as Anchor) is Terra's official DeFi platform launched in March 2021 and is essentially Lending, similar to Compund. However, what makes Ancho special is the extremely high APY (Annual Percentage Yield), which is always maintained around 20%.

Anchor has three characteristics: simplicity, just deposit the UST into Anchor, you can get a fixed income and high interest rate; stability, through multiple PoS blockchain rewards to achieve a stable interest rate; high yield, APY basically maintained at 20%.

So in the Terra ecosystem, the lending agreement Anchor acts as a "national bank", promising ultra-high demand yields of 20% in order to absorb public deposits (in the form of USTs).

How much does Anchor need to spend each year in order to maintain revenue?Anchor's main revenue consists of: interest on borrowed funds + PoS reward revenue on borrowed collateral (currently bLUNA and bETH) + liquidation penalties.Anchor's main expenses include: interest on deposits. Considering that Anchor itself provides a high ANC token subsidy to borrowers and that Anchor as a whole is in a loss-making position, Anchor faces additional ANC token price maintenance costs in order to maintain the ANC token price, i.e. to address the ANC token selling pressure. In other words, Anchor needs to bear about a billion dollars of expenses per year without considering the revenue from clearing, and the cost of ANC token price maintenance, as well as the salaries of team members.

Anchor alone obviously cannot afford this expense. Just this February, as Anchor's reserve pool was nearing its bottom, Terra's ecological fund LFG (Luna Foundation Guard) announced a 450 million UST grant to Anchor to replenish its reserve pool. This confirms the point that Anchor, unlike other lending agreements, is essentially an integral part of Terra's planned economy, and that its current commercial operation is not in pursuit of profitability, but rather a product that is officially funded by Terra and subsidizes the expansion of the UST.

This also allows us to see the complete logic of Terra.

Firstly creating their own DeFi scenario within the public chain and providing subsidies (Anchor as representative), shaping the demand for stable coins.

Demand drives the scale of UST casting and users begin to be brought in.

Improving the data performance of the ecology, such as TVL, number of addresses, transfer activity and the number of projects participating in the ecology.

The boost in metrics reinforces the appeal of Luna's narrative.

Enables the promotion of cooperation with more headline projects based on consensus and improved fundamentals.

Narrative and consensus enhancement, which boosts Luna's trading breadth (number of investors and regions) and trading depth, and progressively pushes up prices.

The beneficial owner receives funds by way of cashing out or destroying Luna.

Use the cash-out funds to continue subsidizing and driving the above cycle.

Risk of death spiral

Of course, the logic of the above lies in the ability of the beneficial owner to obtain funds to support the subsidies provided by Anchor in the form of cashing out or destroying Luna. If obtaining funds and maintaining the subsidies can be done better, the lower the cost of maintaining the above cycle.

If the above link can be well realized, it will show that the external third-party scenario of stablecoin starts to increase and the acceptance scope expands; more native Web3 projects and developers flock to Terra ecosystem, spontaneously build more applications and attract more users. In this way, UST is the engine of Luna, and Luna is the stabilizer of UST. The two interact with each other, and it is easy to form a positive spiral when the trend is positive.

Luna is essentially an invisible collateral for stable coins such as UST. The higher the market capitalization of Luna relative to the stable coin and the better the transaction depth, the more sufficient the collateral will be, the lower the risk of de-anchoring the stable coin and the lower the cost of maintaining consensus, and vice versa, the easier it is to fall into a death spiral. For example, when the cycle is broken and crypto asset prices collapse, the stable coins and public chains where Terra is located are not spared.

In fact, Anchor is certainly aware of the importance of maintaining a circular and subsidized source and is taking steps to increase production reserves, Anchor is adding new collateral assets: bLuna, bETH, wasAVAX, bATOM. it helps to increase Anchor's profits, but it won't change much of the picture. The next step is to introduce anchor dynamic rates. According to the proposal, the anchor yield will fall at a rate of 1.5% per month, with a minimum APY set at 15%, which will be reached in 3 months.

Since most of the demand for UST is based on a single protocol, it is critical that Terra keep the APY high in the Anchor protocol. If Anchor yield reserve goes to 0 or APY goes below the point where people want to keep UST in Anchor, demand for UST contracts and LUNA may fall as people will start selling UST, more Luna will be minted and supply increases Luna prices may fall further.

Overall, with the establishment of LFG and the inclusion of BTC into UST's reserves and redemptions, Terra Eco is trying to keep the business cycle going, but it remains to be seen if it can effectively deal with additional, unexpected complications and prevent a negative spiral in an extreme market.

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Copyrights:Dexnav Posted on May 17, 2022 am10:14.
Please specify source if reproducedWhy is LUNA in a death spiral in one article? | Dexnav Blockchain Navigation Network

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