More Than Buy Low & Sell High —Part 2
It has been a crazy week in the Crypto space with the falls of UST and Luna. To witness a top 10 coin falls from its all-time high of $119.8 to less than 1 cents is something that I could never imagine as the Terra Network consists of great communities of LUNAtics. But I guess, all of us just got humbled this week that nothing is too big to fail in this space even though you are not investing in meme coin.
Even though I do not have any position in either Luna or UST, the ripple effect from what happened could still be affecting the space as a whole. And I hope it’s for the better, just like how the collapse of Lehman Brothers did to the financial institution? Or we might end up going back full circle again.
After all, everyone always speaks of the market as a cycle.
Even after the dust had settled, there are still a few questions lingering on everyone’s mind on what’s next for Terra Network as validators and stakers are looking for an answer on what they need to do with their bags.
Besides that, the biggest question of what happened to Luna Foundation Guard’s (LFG) Bitcoin reserve of more than 40k (roughly around $1.275 billion in value), and how much was utilized during this ‘Co-ordinated’ attack? As such reserve has been prepared in the event of de-pegging of UST were to occur.
Update Note: LFG had provided the details of how the reserve is being user and it is quite scary knowing that more than $1 Billion has been used to defend the depeg but the dominos effect is bigger (LFG Tweet)
Many outsiders are viewing this as the fall of Cryptocurrencies. Although the ripple effect can be felt throughout the entire space this week, the real story is far from that. It is unknown yet what this event will unravel (at least for me). But the event that transpires this week is just a proof that the UST model of Algo Stablecoin does not work and not the failure of Crypto as a whole (at least not yet?).
We might need to look for a new model of stable coin (or adopt the current working model and improve it further) or more interestingly, maybe we might be seeing a consolidation of stablecoins?
If you are looking to understand further what happened this week, a deep dive into Algo Stablecoin/Algorithmic Stablecoin would give you a better understanding of what happened as the model for UST is different from other collateral backed stable coins such as USDT/DAI. As the LFG is aiming at creating a fully decentralized stablecoin.
Alright, enough talking about what had happened and let us continue from my last article. The biggest question from the last article — if borrowing in crypto works via over collateralization, why people still borrow from it?
1- Creating Leverage Position a.k.a Borrowing on Steroid
I got to be honest, it sounds a little bit scary to talk about leverage when it comes to trading/investment. That’s why you should exercise caution before doing so.
But we did a lot of leveraging in the TradFi world too by leveraging our monthly salary against our Debt Service Ratio (DSR), coupled with our good CCRIS report to obtain our Hire Purchase Loan to buy that new Myvi or a mortgage for that new condominium with easy access to MRT instead of paying the full amount in a single transaction to obtain them.
let’s set an example using UST & $LUNA, shall we?
UST is the stablecoin used in Terra Network and similar like our fiat Malaysian Ringgit Money, UST has an interest-bearing potential if you use it wisely. Similar to the TradFi world, depositing your money into a bank either you left it sitting in your savings account earning an interest rate of 0.25% — 0.8% p.a or you can lock them for a certain period into Fixed Deposit earning an interest rate of around 1.25% — 2% (depending on the bank & locked period).
Although there are a lot of ways to earn passively with your stablecoin, and with UST, one of the most famous protocols is the Anchor protocol which will allow you to earn a passive interest of 18% APY (based on the latest figures before the ‘bank-run’).
How can you leverage if you are undercollateralized?
For the sake of this example, we will be looking at 2 protocols:
- Anchor — Terra Network Lending & Borrowing protocols (refer above for its return)
- Degenbox — Abracadabra’s UST strategic program that allows us to utilize the non-interest bearing token. Abracadabra also has its own stablecoins and coins ($MIM and $SPELL).
Let’s for simplicity’s sake we made up the scenario below.
Let’s say you own 1,000 UST. Now instead of depositing all the UST into Anchor to get 18% APY, you can deposit this into the Degenbox.
- 1,000 UST deposit into Degenbox’s Cauldron as collateral to borrow $MIM (Abracadabra’s collateralize varies from 20% up to 90%). Let’s say we are an adrenaline junkie and we are adjusting our borrowing leverage to 90% or around 9X.
- What will happen is the protocol will keep on looping borrowing MIM (using your UST that is being sent into Anchor protocol as collateral) and Swapping UST in a loop up to 9X. Hence from just the 1,000 UST that we initially have, we can end up with around 25,482 $MIM which can be swapped into almost the same amount of $UST.
- Degenbox strategy is performing this loop behind the scene and you can see the approximate APY as per snapshot below.
- So, instead of only earning 18% APY from 1,000 UST (around 180 UST/Year), you can now earn around 156%!
Now, assuming you obtain your UST by using ETH or BTC as the initial collateral for the first level of borrowing instead of starting at 1,000 UST you will be starting at a higher amount of UST instead.
Hence, the term; borrowing on steroid.
Is It Advisable?
Of course not! You can easily check the probability of you getting liquidated by checking the graph on how consistently UST managed to maintain its parity of 1:1 with the US Dollar. And since there’s a room for arbitrage profit due to the nature of UST Tokenomics and Algo-Stablecoin where it’s undercollateralized, we can see what happened when an attack on the UST peg occurred, a domino effect which contribute to its bank run and the loss of value for its governance token $LUNA and also UST.
Unfortunately, this does not stop many of us from doing so. But as many would argue, what had happened last week needs to happen to allow for a better tokenomics, protocols and foundation in place before we get to a more stable ecosystem.
But as for now, the speculative nature of Cryptocurrencies remains where besides a good system a great narrative will get more people buying into them.
