TerraUSD (UST) – Deep Dive
1) Exact Mechanics: How UST Tried to Hold $1
Mint/Burn Convertibility
Protocol allowed 1 UST ⇄ $1 of LUNA (by protocol price). If UST < $1, arbitrage was to buy UST and redeem for $1 of LUNA; if UST > $1, burn $1 of LUNA to mint UST and sell.
Where Demand Came From (Anchor)
UST demand concentrated in Anchor deposits offering high yields. This skewed the holder base toward yield‑sensitive users, amplifying exit risk when rates or confidence changed.
Liquidity & Bridges
Key on‑chain USD liquidity for UST lived in Curve pools on Ethereum. Rising pool imbalance (UST share spiking) often preceded price breaks.
BTC Reserve (LFG)
Luna Foundation Guard acquired BTC to backstop the peg. Effectiveness hinged on reserve sufficiency, deployment speed, and market confidence.
2) Why It Broke (Design Fragilities)
Reflexivity
Defending UST below $1 mints more LUNA. Larger supply → lower price → more LUNA needed per redemption → spiral.
Concentrated Demand
Reliance on Anchor meant exits were correlated and fast when yields/confidence shifted.
Liquidity Mismatch
UST supply outgrew deep USD liquidity; modest sells moved price (slippage) and worsened expectations.
Reserve Limits
BTC reserves were finite and themselves pro‑cyclical (value falls in risk‑off), undermining peg defense.
3) Timeline of the Depeg (Illustrative)
- Trigger: Large UST sells on Curve/CEX → pool imbalance → UST $0.99–$0.98.
- Redemptions: Traders buy UST < $1, redeem for $1 in LUNA; LUNA supply expands quickly.
- Spiral: Falling LUNA → next redemptions mint even more LUNA per $1 → dilution accelerates.
- Reserve Deployment: BTC sold to support peg; perceived insufficient as fear rises.
- Confidence Breaks: Anchor withdrawals + UST sells overwhelm liquidity; UST trades to cents.
- Aftermath: Chain halt; proposals to reconstitute sans UST; contagion to DeFi lenders/pools.
Focus on the feedback loop between redemptions and LUNA price, not exact timestamps.
4) Death‑Spiral Math (Toy Model)
If price falls by x%, next redemptions mint ≈ 1/(1−x) more LUNA per $1 — ignoring frictions.
5) Early‑Warning Dashboard (Heuristic)
High pool imbalance + fast Anchor exits + steep LUNA drawdown + rapid supply growth ⇒ elevated depeg risk.
6) Comparisons
UST vs. Bitcoin vs. Ethereum
| Dimension | UST (algo) | Bitcoin (BTC) | Ethereum (ETH) |
|---|---|---|---|
| Price Target | $1 via convertibility & ops | None (market‑driven) | None (market‑driven) |
| Backing | Endogenous (LUNA) + finite reserves | Scarcity (21M), network security | Utility (gas), PoS security |
| Primary Use | Stable unit for DeFi/payments | Store of value / settlement | Smart‑contract platform token |
| Failure Mode | Peg break / death spiral | Volatility (no peg risk) | Volatility; contract/fee risks |
| Defense Tools | Mint/burn, reserves, governance | None (market only) | Fee market, upgrades, L2 scaling |
| Regulatory Focus | High (payments/redemption) | Medium (trading/AML) | Medium‑High (DeFi/securities) |
| Where It Lives | Terra (+ bridges) | Bitcoin network | Ethereum network |
Key: BTC/ETH don’t defend a peg. UST had to prove $1 convertibility; once confidence slipped, defense mechanics amplified losses.
Stablecoin Matrix: USDC / USDT / DAI / FRAX / UST
| Stablecoin | Backing | Redemption | Transparency | Main Risks | Where |
|---|---|---|---|---|---|
| USDC | Fiat reserves (cash/T‑bills) | Issuer redemption (KYC) | High (attestations) | Banking/counterparty | Multi‑chain |
| USDT | Fiat reserves (varied) | Issuer redemption (KYC) | Medium (reports) | Reserve opacity/regulatory | Multi‑chain |
| DAI | Over‑collateralized crypto + RWA | On‑chain modules (indirect) | On‑chain + reports | Collateral volatility, governance | Ethereum |
| FRAX | Hybrid (partial collateral) | Protocol mechanisms | Medium | Model/market risk | Ethereum |
| UST (hist.) | Endogenous (LUNA) + finite BTC | Convertibility to LUNA | Medium | Death‑spiral reflexivity | Terra |
7) Quiz – Self‑Check
- Why did mint/burn convertibility amplify the UST depeg?
- Name two early‑warning metrics that flashed.
- Contrast UST with Bitcoin and Ethereum in one sentence.
- What’s the main difference between UST and USDC/DAI?
- Redemptions below $1 expanded LUNA supply as its price fell → lower price → even more LUNA per $1 next round → reflexive spiral.
- UST share spiking in Curve pools (imbalance) and rapid Anchor withdrawals (outflows).
- UST must defend a $1 peg with mechanisms that can fail; BTC/ETH float without a peg, so no peg‑mechanics collapse.
- USDC is fiat‑backed with off‑chain reserves; DAI is (mostly) over‑collateralized on‑chain; UST relied on endogenous LUNA value plus finite reserves.