Last month the world discovered that the “stable” in “stablecoin” is more an aspirational endeavor than planetarily ordained fact. The TerraUSD algorithmic stablecoin, or UST, maintained its peg to the U.S. dollar with remarkable fidelity for 19 months. Then it didn’t. From May 7-14, the coin went from a dollar to roughly 13 cents, a tailspin it could not recover from. Today, UST is worth less than four cents, and even that is probably an overvaluation.
So what went wrong? At a conceptual level, the idea behind the algorithm was rather tidy. On one hand was the UST stablecoin, and on the other was its partner, the Luna governance token. Investors were monetarily incentivized to fiddle with these two dials via arbitrage so that the peg would never stray far from the dollar. The theory was solid, but like many great ideas, predicated on some naivete.
The design of the UST/Luna system presumed that transactions on its blockchain would be comprised primarily of small, steady movements by rational and goodwilled actors. It failed epically the moment it faced rapid, lopsided offloading on one half of the scale, and the widespread panic-selling that ensued. As to why such lopsided offloading occurred to begin with, there are several postulations. One of them suggests it was spawned by a personal vendetta against Do Kwon, Terra’s CEO. Another one is that investors simply wished to monetize Luna gains to offset the effects of inflation.
Whether the depeg was the result of coordinated malice, natural trading patterns, or random chaos is in one major way irrelevant; the UST coin permanently decoupled from the dollar within the constructs of Terra’s own rules. There was no hack, no rug pull, no theft. Simple stress broke it. Billions of dollars tied to the Terra network evaporated within days. The collapse was staggering.
While nothing on this blue planet is invincible, there is such a thing as better design. UST/Luna couldn’t even survive its first real pressure test, meaning failure was inevitable. Last week, Luna hardforked as a last-ditch effort to retain value. The odds of success for the new chain are anyone’s guess, but the programming of all future algorithmic stablecoins will likely be slightly better off because of the painful lessons learned from the UST peg break.
With apologies, “likely be slightly better” is all the optimism we can muster in good conscience. Bear in mind, the presumption of what is “likely” is predicated upon a model of small, steady movements by rational and goodwilled actors. Take it with a dollop of skepticism because real life is a trickier thing.