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SwissBorg report explains reason behind the “loss of life spiral” of UST

The Swiss-based crypto trade, SwissBorg, has launched a report on the dangers surrounding Terra’s stablecoin, UST. The token is at the moment present process excessive volatility, buying and selling at simply $0.59 at writing. SwissBorg issued a threat warning to customers on Might 10 and paused withdrawals of UST on the identical day, hours earlier than Binance adopted go well with. The report was accomplished in April, and nearly the entire dangers they recognized are at the moment enjoying out.

Dangers of TerraUSD (UST)

Not like different stablecoins similar to USDT or USDC, backed by fiat collateral and different liquid belongings, UST is an algorithmically baked token. CryptoSlate has obtained a report from SwissBorg’s DFi crew on UST dangers. The report defined, “at any time, customers on Terra can burn $1 of LUNA to mint 1 UST, or burn 1 UST to redeem $1 price of LUNA. Subsequently, the destiny of UST and LUNA are intently linked, and so are the dangers concerned.” Importantly. It highlighted 4 key areas of threat;

  • A loss of life spiral of UST-TerraLuna
  • Anchor Protocol dangers
  • UST lack of peg
  • A structured mannequin for default.

Demise spiral of UST-TerraLuna

SwissBorg recounted a possible “loss of life spiral” between TerraLuna and UST which might trigger LUNA to crash and additional emphasize a financial institution run on UST. LUNA is at the moment buying and selling down 90% since Might 9, indicating that this state of affairs is now enjoying out with UST additionally down 30%. The report explains the loss of life spiral intimately.

“If LUNA’s worth is below strain, UST holders may very well be fearing that the UST peg is in danger and determine to redeem their UST positions. So as to take action, UST is burnt and LUNA is minted and bought in the marketplace. This could exacerbate additional the decline of LUNA’s worth, pushing extra UST holders to promote their UST. This vicious cycle is know and ‘financial institution run’ or ‘loss of life spiral’

UST death spiral
Supply: SwissBorg UST Danger Report

Anchor Protocol Danger

Anchor Protocol is the Terra ecosystem platform that gives excessive curiosity in UST staking. The platform has provided as much as 19% in current weeks with a peak TVL of round $15 billion. The TVL has plummeted over the previous few days, with each deposit and borrow values free falling.

Anchor TVL
Supply: Anchor Protocol

SwissBorg recognized the chance right here as “if the worth of LUNA (and bLUNA) falls, this might set off a liquidation of the LUNA collateral positions. UST would then be burned again into LUNA, additional exacerbating the LUNA worth lower.”

By way of reviews from customers on Twitter, quite a few buyers have been unable to entry their Terra Station wallets resulting from community congestion resulting in liquidations.

An incapability to entry wallets has precipitated customers to be unable to deposit funds to lower their LTV, forcing liquidation. This seems to be partly liable for the steep decline in LUNA’s worth over the previous week. SwissBorg particularly acknowledged of their report that “any difficulty with Anchor would seemingly trigger a cascade of UST redemptions with all the implications beforehand talked about.”

UST lack of peg

Swissborg outlined a possible state of affairs whereby “a loss of life spiral together with a cascade of liquidations in Anchor might trigger the market capitalization of LUNA to fall beneath the market capitalization of the circulating UST.” As seen on the CryptoSlate coin tracker, this has now performed out, with LUNA dropping to only $370M in market cap.

luna cap
Supply: CryptoSlate

SwissBorg recognized this example alone as being extremely correlated with a threat of UST de-pegging. The present state of play has this as simply one of many components affecting the Terra ecosystem. The beneath graph exhibits an occasion in Might 2021 the place the market cap crossed for a short interval and its impact on the UST peg.

ust luna cap crossing
Supply: SwissBorg UST Danger Report

Structured mannequin for default

SwissBorg recognized the Merton mannequin for assessing the chance of default as making use of to an evaluation of the dangers related to UST.

“The Merton mannequin makes use of the Black-Scholes-Merton choice pricing strategies and is structural as a result of it supplies a relationship between the default threat and the asset (capital) construction of the agency.”

The report illustrated how the advanced formulation used within the Merton mannequin analyses the chance of an asset falling beneath its legal responsibility threshold, as proven beneath.

merton model
Supply: SwissBorg UST threat report

Regarding the Terra ecosystem, the report decided the chance of UST dropping its peg.

• Asset worth A is represented by the market capitalization of LUNA
• Liabilities worth L is represented by the market capitalization of UST
• if at a given time horizon T the market cap of Luna is smaller than that of UST, the UST peg is misplaced

The above knowledge was charted to point out the chance of UST dropping its peg day by day. In Might 2021, the chance rose to only below 100% earlier than falling again to twenty% in November. The risk had been steadily rising to 60% as of April 2022. At current, UST, buying and selling at $0.59, has definitively misplaced its peg.

Danger conclusions

SwissBorg concluded that “the destiny (and dangers) of UST are strictly linked to that of LUNA. Any convergence out there capitalization of LUNA towards that of UST poses severe dangers of dropping the peg.” Their suggestion was to observe the place of UST with LUNA intently, watch the TVL of Anchor Protocol for a decline, monitor market volumes for LUNA to make sure liquidity, and monitor for a lower in demand for Terra stablecoins.

At current, all of those circumstances are true. LUNA has dropped 90%, UST is down 30%, Anchor Protocol TVL is down 60%, and demand for Terra stablecoins is flatlining. Additional, a drop within the whole market cap of crypto as a complete has created an ideal storm for a black swan occasion regarding the Terra ecosystem. Will Terra survive this storm, or are tens of billions of {dollars} price of tokens about to be wiped from the face of the earth?

No matter whether or not Terra can get well, there are many buyers who will be unable to resulting from Anchor Protocol liquidations.



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