Try Quests to earn cryptoUST "Collateralization"
This dashboard shows if UST is indeed collateralized by LUNA.
Based on the findings above, a few conclusions can be drawn:
- Is UST fully collateralized?
- No.
- Is LUNA used to maintain the peg?
- No.
- What is maintaining the peg then?
- Arbitrageurs who believes 1 UST = 1 USD banking on the difference between the value of UST and USD by swapping UST to LUNA and vice versa, and external factors such as Uniswap arbitrageurs trading on the difference between the swap rate of UST and USDT
- So what is the relationship of LUNA and UST?
- When LUNA's price is higher, more UST can be minted. After minting, LUNA acts as an incentive for arbitrageurs to maintain the peg. LUNA's price also shows the demand of UST. When the demand of UST is high, more LUNA is burned to mint it, thus decreasing the supply of LUNA, which in turn increases LUNA's price. The decrease of the price of LUNA after the minting of UST does not affect UST, since UST's price is not maintained through the collateral of LUNA.
- Is the collateralization of LUNA important to ensure the stability of UST?
- Based on these data, no.
Based on the graphs below, not much has changed since December 2020, where the public LUNA worth is less than the total UST supply, making it undercollateralized. However, the price is at the most stable since inception, proving that the growth of Terra's userbase, which indirectly increases the amount of arbitrageurs, is much more effective in maintaining the peg.
By comparing public LUNA's USD Value to the UST supply, we can see that even after a few months from December's instability period, public LUNA was still worth less than the total UST supply, however the price of UST during this period was much more stable compared to December 2020. The sharp decrease of LUNA's worth appear to only have a little effect on the UST supply, proving that collateralization of LUNA is not an important factor in maintaining UST's peg to USD.
To further prove the above point, another period of instability is chosen, namely the cryptocurrency market crash in May 2021, where the price of LUNA went down by more than 75% from its all time high. It should be noted that the userrbase of Terra had grown tremendously compared to December 2020.
Based on the findings above, a conclusion can be drawn that arbitrageurs are needed to maintain the peg. Seeing that UST was undercollateralized during this period, the presence of LUNA can be said to provide incentives to maintain the peg, however it does not guarantee that 1 UST will always remain pegged to 1 USD. UST being undercollateralized during this period showed that LUNA does not collateralize UST, however, it does provide incentives for arbitrageurs to maintain UST's peg.
So, how can we be certain that the lack of arbitrageurs caused UST to remain unpegged for a prolonged duration in the Terra ecosystem? In order to find if this is true, an external source where the user count is higher than Terra is required. This is where the USDT-UST Uniswap V2 pool comes in, with the amount of users on Uniswap, arbitraging shouldn't be an issue. Based on the average USDT per UST graph as seen below, we can see that UST swung between the +- 0.5% range during this period, which is a much more acceptable value compared to the values obtained in the graphs above.
The graph below shows the difference between the % difference of the offer amount vs the ask amount of the LUNA to UST swap pair and the % difference of the offer amount vs the ask amount of the UST to LUNA swap pair, where a positive value means swapping UST to LUNA is more preferable and where a negative value means swapping LUNA to UST is more preferable. Through observation, it is found out that Terra worked as expected during this time of instability, where swapping LUNA to UST is in a more favorable position when UST is worth less than 1 USD and vice versa. With a difference going as high as 4.6%, it leads to the hypothesis that few users are banking on the difference, which coincides with the above findings.
Based on the graph below, it can be seen that the decrease in UST value is caused by the increase in UST supply. With no corrective actions by arbitrageurs (decrease UST supply), UST remained unpegged.
This is shown clearer by comparing the public worth of LUNA during this period to the price of UST. From the graph below, it is can be seen that despite the increase in the public worth and public supply of LUNA, with only few users to actually bank on the difference by swapping UST to LUNA, UST continued to be unpegged from USD far longer than expected. It can also be seen that during this period, publicly available Luna was worth less than the supply of UST, which means that UST was undercollateralized.
The graph below shows the public LUNA supply vs the price of UST during the instability period of Dec 2020 to Jan 2021. From the graph, we can see that when the price of UST decreased, the supply of LUNA increased. This behavior is expected as the increase in LUNA supply is to absorb the loss sustained by UST and return UST to its peg. However, due to Terra being quite young during this time, the lack of arbitrageurs to profit on the difference in value between UST and USD caused the prolonged depeg of UST to USD.
By definition, collateralization means that the value of an object is secured by another object of similar, usually higher, value. Since the word collateralize is used in the documents, the total value of LUNA in USD must be worth more than the total value of UST in USD to justify its peg to USD, and since Terra heavily relies of arbitrageurs to maintain the peg, only liquid and publicly available LUNA is used in the calculations. Another reason behind using liquid and publicly available LUNA is that UST must be able to be fully redeemed for 1 USD worth of LUNA at any given time to be deemed as collateralized, as staked LUNA or LUNA that are locked in smart contracts cannot be swapped. In order to calculate if UST is actually pegged to USD by using LUNA as collateral in the past 14 days, data from the the time when the value of UST is unstable (25 December 2020 to 15 January 2021), and during its sharp drop in May 2021 are obtained and compared to the data from the past 14 days.
So where does the swapping occur? Based on the documents, swaps happen on a "protocol-level market-maker", which can be theorized to be the Native Swap function in Terra. Based on this assumption, Native Swap is used to determine the price action when UST starts to depeg from USD.
Terra houses a number of stablecoins that are so-called "collateralized" by LUNA. For example, 1 UST can always be swapped to 1 USD worth of LUNA, thus the UST is "collateralized". In other words, when the price of UST drops below 1 USD, it can still be swapped to 1 USD worth of LUNA, thus retaining its value of 1 USD, whe drop in value is absorbed by the holders of LUNA. The reverse happens when the demand of UST is high, which means more users are buying UST (therefore increasing its price and losing the peg), arbitrageurs can use 1 USD worth of LUNA to mint 1 UST, which in turn increases the supply of UST and bring down the price of UST. Based on the explanation, Terra heavily relies of arbitrageurs to maintain the peg of its stablecoins.