Try Quests to earn cryptoRedemption Arc (Terra Bounties)
Q177. Explore the limitations of redemption on Terra, i.e. the burn and mint mechanism. In what scenarios would the ability to burn & mint be insufficient for demand? Using data, illustrate occasions where these scenarios have occurred or come close to occuring. There are a number of ways to do this; one approach is to quantify a “Redemption Utilization”, i.e. a performance metric that encapsulates the extent to which demand for redemptions outstrips or comes close to the programmed caps, and then to explore the number of days over a specified time period that this metric has crossed a concerning threshold.
Introduction
New and powerful trend in the world of decentralized financial applications (DeFi) is stablecoins with mechanism on base of algorithmic method. And firth oh that is TerraUSD (UST) that are leading decentralized stablecoins with its stabilization mechanisms, adoption history, and risks. Redemption of UST when accruing that marketcap of LUNA as collateral below the UST markectcap on liqidity pools on anchor.
The stabilization mechanism for TerraUSD (UST)
Terra uses a dual token system for maintaining the fiat peg. On the one hand, the LUNA token is used for paying network fees, holding governance votes, participating in the consensus process (PoS), and minting stablecoins. But the real stablecoin is TerraUSD (UST), whose binding is ensured by a unique seigniorage system.
The majority of traditional stablecoins are backed by deposited assets that can be redeemed or liquidated in the event of a binding loss. Terra’s system instead uses a burn mechanism in conjunction with the platform token LUNA. To create a new TerraUSD (UST), the same dollar amount in LUNA must be destroyed. Thus, 1 dollar in LUNA can always be exchanged for 1 UST and vice versa. This creates an arbitrage opportunity for market participants if the TerraUSD exchange rate differs from 1 dollar. Also, the mechanism exerts deflationary pressure on LUNA if UST gains adoption.
The mechanism of Anchor protocol
After launchin Anchor protocol that developed by Terraform Labs, in March 2021 that created in part to increase aggregate demand for UST, fluctuating returns on Terra Stablecoin deposits (around 20% per year) offers low with decentralized savings anchor protocol.
limitations of redemption on Terra
The Thread for TerraUSD, as same as other algorithmic stablecoins, staying in 1:1 relative dollar peg. Since UST is directly linked to the LUNA token, large price fluctuations can drastically affect the peg. With a market cap of $22 billion, the number of UST (11 billion) is currently “backed” by enough LUNA. However, if the market capitalization of the LUNA token falls below the 11 billion mark (around -50%), a loss of commitment becomes increasingly likely. This is exactly what happened during the general market crash on May 23, 2021, when the 2 billion UST was only covered by 1.6 billion USD in LUNA.
How Anchor is working on returns of critical to UST binding
As mentioned earlier, the majority of UST demand comes from the Anchor savings protocol, which offers a very attractive return on stablecoins at just under 20% per year. But as money market rates and staking yields fluctuate along with the market environment, the protocol has established an emergency reserve pool. In times of a weak market, Anchor can access these reserves to ensure continued high returns. According to Terraform Labs, this is a temporary solution until UST demand on other platforms is sufficiently high.
Redemption on UST
Once the reserve pool is empty, Anchor returns will be left entirely to market forces. If current mechanisms cannot guarantee a 20% return, this would have a negative impact on UST demand. Capital migration to other platforms with more attractive opportunities would lead to large-scale UST redemption and put corresponding downward pressure on the LUNA price. With a falling LUNA price, the likelihood of a commitment loss then increases, exacerbated by leveraged positions on Anchor (leveraged UST with deposited LUNA collateral).
LUNA community risk exposure & procedures
Capital migration on every defi ecosystem is the major risk that tread that. since to address this risk, the LUNA community has decided to replenish the reserve pool again with $450 million to ensure 20% p.a. returns on Anchor for three more quarters and prevent capital migration for the remainder of the year.
Other LUNA procedure for settlement this problem so-called “White Whale” protocol. The Terra decentralized platform uses arbitrage opportunities between LUNA and UST to generate additional returns on deposits. In the event of a commitment mismatch, White Whale can access deposited UST holdings and restore the commitment through arbitrage. Combination of this project with Anchor protocol, make an important contribution to supporting the TerraUSD stablecoin, while not completely eliminating the risks of a binding loss.
References: Crypto Valley Journal