You give me a dollar, I give you a digital currency equivalent. When you need your real USD back, you tell me and I give it to you. That means in an ideal world, you have your stable coins backed 1:1 with real USD.

Of course, this isn’t always the case, and with Tether, there has been much scrutiny over the years that they do not have the USD collateral to back their stablecoin.

Ok, but let’s assume Tether has the USD. Why is it depegging? This is most likely due to sell pressure and Tether’s ability to liquidate their USD holdings. I think Tether has more than enough real USD to deal with the sell pressure we’re seeing now, but the system is having a hard time keeping up.

How does the sell pressure play out? Is this other people willing to sell for 99 cents, 98 cents on exchanges because Tether can’t fulfil orders fast enough? I assume they are always willing to buy at $1 else it all collapses?

AFAIK, Tether will not convert to USD for you unless you register and have >100k Tether. Therefore, most holders only ability to “cashout” is on exchanges. Obviously, this is problematic.

Compounding with this is that when you move money to exchange you have some USD there. But then to actually trade either you receive some stable coin or have to first trade for one...

Probably applies only to some, but still a real insane thing...

This is an amazing explanation. Thank you!

That explanation is not correct. Algorithmic stablecoins rely on a pairing with another crypto, in UST’s case LUNA. 1 UST can always be swapped to $1 US dollar of LUNA. It is interchangable, so $1 US dollar’s worth of LUNA can also be swapped for 1 UST. Hence, the “algorithmic” in the name. This way traders are always incentivized to keep the price of UST at $1.

There is no collateral requirement. In UST/LUNA’s case they had collateral, mostly in Bitcoin, in the Luna Reserve Guard but their collateral proved insufficient. Some algorithmic stablecoins are entirely uncollateralized.

That's all irrelevant, since Tether is not an algorithmic stablecoin, and they claim to have 1:1 reserves for every USDT.

The parent comment was edited to remove the section on UST after my comment.

I still don’t follow why the second currency is required?

They will always swap a UST for $1 of LUNA so a UST is implicitly worth $1.

LUNA itself doesn’t have anything behind it though apart from concidence. So we have a stablecoin manufactured from a volatile unbacked asset where the market cap can fall arbitrarily low.

I know it failed, but it’s not quite clicking for me what they were even trying?

The second currency is required for the same reason that three card monte requires three cards.

Ponzis can be very profitable. I think algorithmic stablecoins are stupid too.

And if the LUNA/USD market becomes insanely volatile or the liquidity vanishes, the algorithm will fail.

fyi ampleforth is an example of a algorithmic stable that doesn't pair with another crypto. Some algorithmic stablecoins incorporate a rebase mechanism when the price deviates from the peg.

Your explanation is incorrect, please see my reply to the comment under yours. You should edit it so people aren’t misinformed.

I removed the section on Terra. Like I said, I didn’t want to get into complicating the explanation, but point taken on the nature of algorithmic stables as opposed to collateralized one. The point I was trying to make was that Terra actually did have collateral, in the form of BTC.

Tether the company guarantees it will buy all tether for $1 each. The drop in price reflects people suddenly realizing they can’t do that if everyone tries to turn in their tether at once.

Surely it is very difficult for a company to "guarantee" anything about the price of a commodity sold in a large open market. There are all sorts of reasons prices go up and down, it seems hubris to imagine you can tether anything.

Even national governments struggle to do this. https://en.wikipedia.org/wiki/Black_Wednesday

It would not be that difficult to guarantee Tether price if tether actually did what they originally claimed. Take usd in, store that in diversified bank accounts/liquid treasuries, and if there ever is downward pressure on the Tether price, use your high quality liquid reserves to buy Tether back (while making profit!). And of course, if you are open and audited on your operations, there is very little reason for a downward pressure for the price.

Now, of course, if you decided to _not_ be open and _not_ hold your reserves in safe assets but instead decided to invest the reserves to speculative gambling tokens or shady commercial papers, then it really is difficult to keep the guarantee if the gambling token loses value.

Theoretically, they could guarantee it by just holding all dollars they are given originally.

A price is just an abstraction for the willingness to buy and sell. If you know there are 1000 of some token in the world, and you have 1000 of some item, you can guarantee that people will always be able to buy one item for one token - by selling your items to them at that price.

But of course, just holding the dollars makes it hard to profit.

Credit cards do it by charging transaction fees.

In theory you should be able to do it if you always have reserves worth more than the total number of outstanding tether. If you distribute 40b tether and have $50b in liquid cash, you can guarantee that you will pay exactly $1 for each tether. Obviously everyone holding your coin is exposed to changes to the value of your dollars, but you can always give them $1 for 1 tether. The problem is of course that you can make a great deal more money for yourself if you invest in riskier ways than holding liquid cash.

I don't think the Black Wednesday situation is similar, because the UK was never going to be able to hold enough of the currencies it was supposedly pegged to to make that same promise. Definitely not my expertise there though!

No, it is not very difficult if your currency is completely covered by an asset it’s pegged to. Many modern currencies work that way.

gee, that sounds like... a bank run.

Market pricing and arbitrage pegs it, is how I understand it.

It's "worth" whatever price the bid-ask spread meets at.

It's exchangeable for USD to the company. As long as there isn't a bank run where they'd stop fulfilling exchanges, when the price drops below $1 anyone can arbitrage it. It reached like 95 cents earlier, anyone could've bought millions of it and got USD for it at like 6% profit. It creates buy pressure/price support as the price falls.

They are backed by real dollars that they have in cash reserve in a bank. At least in theory.

What is currently happening is because of too much volume they have hard time putting more money back into the ecosystem (which is the good scenario, it means they have money but things are going just a bit slow), or they are running out of money (which is a bad scenario that would cause many things to go down with it).

Matt Levine did a great write up of algorithmic stablecoins here: https://www.bloomberg.com/opinion/articles/2022-05-11/terra-...

"1. You wake up one morning and invent two crypto tokens.

2. One of them is the stablecoin, which I will call “Terra,” for reasons that will become apparent.

3. The other one is not the stablecoin. I will call it “Luna.”

4. To be clear, they are both just things you made up, just numbers on a ledger. (Probably the ledger is maintained on a decentralized blockchain, though in theory you could do this on your computer in Excel.)

5. You try to find people to buy them.

6. Luna will trade at some price determined by supply and demand. If you make it up on your computer and keep the list in Excel and smirk when you tell people about this, that price will be zero, and none of this will work.

7. But if you do a good job of marketing Luna, that price will not be zero. If the price is not zero then you’re in business.

8. You promise that people can always exchange one Terra for $1 worth of Luna. If Luna trades at $0.10, then one Terra will get you 10 Luna. If Luna trades at $20, then one Terra will get you 0.05 Luna. Doesn’t matter. The price of Luna is arbitrary, but one Terra always gets you $1 worth of Luna. (And vice versa: People can always exchange $1 worth of Luna for one Terra.)

9. You set up an automated smart contract — the “algorithm” in “algorithmic stablecoin” — to let people exchange their Terras for Lunas and Lunas for Terras.

10. Terra should trade at $1. If it trades above $1, people — arbitrageurs — can buy $1 worth of Luna for $1 and exchange them for one Terra worth more than a dollar, for an instant profit. If it trades below $1, people can buy one Terra for less than a dollar and exchange it for $1 worth of Luna, for an instant profit. These arbitrage trades push the price of Terra back to $1 if it ever goes higher or lower.

11. The price of Luna will fluctuate. Over time, as trust in this ecosystem grows, it will probably mostly go up. But that is not essential to the stablecoin concept. As long as Luna robustly has a non-zero value, you can exchange one Terra for some quantity of Luna that is worth $1, which means Terra should be worth $1, which means that its value should be stable.

All of this is, I think, quite straightforward and correct, except for Point 7, which is insane. If you overcome that — if you can find a way to make Luna worth some nonzero amount of money — then everything works fine. "

An important distinction between Terra (what is being described there) and Tether (what this thread is discussing), is that Tether claims to be backed by real assets.

There is no strong distinction in backing: USDT just has a slightly more believable story.

Also the price of a stablecoin can shift from it's peg, even if it has 100% backing, when there is latency/congestion/spread/volume for the arbitrage trade.

That said, there is a whole heap of plenty of evidence that USDT is not backed by dollars 1:1.

One thing I don’t understand here: where does the smart contract get the information of the current luna/usd exchange rate? It can’t be an api call surely, it must be on-chain somehow.

Validators vote on the current exchange rate.

https://docs.terra.money/docs/develop/module-specifications/...

Do I understand this correctly: there's no inherent incentive to put the "correct" price, they just need to agree with each other. Essentially playing "Guess 2/3 of the average" but it's just "Guess the average".

Validators have staked a lot of LUNA and it's in their best interest not to crash the ecosystem.

Ah, that makes more sense. Thanks for the link, all this stuff is so interesting from a thought experiment point of view.

It's really fascinating all of the stuff that exists or at least has been tried out in the cryptocurrency space.

Miners put the price (in dollars) in the blocks, and the medium price is taken as the price. You get penalized if the price you put in is 1 standard dev. or more off. You get 1% less of the block award you would get normally.

Things like this rely on off-chain "oracles"

I know the thing is crashing and burning as we speak, but that seems like a crazy single point of failure for something claiming to be decentralized...

What if the oracle has downtime?

Many Many nodes :) i.e distributed

There is also the point that once trust in this ecosystem erodes, there will be tremendous pressure on Luna as people try to get rid of both their Luna and their Terra, and whatever you did to achieve 7 may just suddenly disappear. The spiral that's happening now.

And what coins do is in effect marketing for all other coins. If one stablecoin crashes, trust in others will erode.

> All of this is, I think, quite straightforward and correct, except for Point 7, which is insane. If you overcome that — if you can find a way to make Luna worth some nonzero amount of money — then everything works fine. "

Their solution was to staple a HYIP scheme to the side of it-- a service where you can deposit coins and get a 20% annual return.

...

> If you make it up on your computer and keep the list in Excel and smirk when you tell people about this, that price will be zero, and none of this will work.

This made me genuinely laugh out loud! But not just because it's funny, but it's also the essence of all digital coinage.

I don't understand.

How do you ensure you have enough Luna to maintain the exchange? If you hold enough Luna but then the price of Luna goes down, where do you get your extra Luna from? A run on your promise kills you.

You just mint Luna at will.

The problem occurs when the amount of Luna that trades for $1 becomes undefined because nobody is willing to do the trade anymore.

Eh, but minting Luna increases the supply of Luna and thus devalues it, therefore a run means that the price of Luna increasingly drops as you mint more, meaning you have to mint more Luna, it heads to zero, you're dead. It's the opposite of stable, because a run actually accelerates itself. What am I missing here?

When the price drops, people on reddit start saying "buy the dip it's going to the moon!" to lure in some new marks.

In the long run you're right though. Eventually you run out of people who believe them and you get the events of the last few days.

You're not missing anything, that is literally how it works and the reason it is now failing.

The balance is ostensibly that you do get some tangible rewards for Luna. But when the expected value of those drops below the outstanding balance as well, you still have a death spiral.

So you’re saying it’s always been a contest of belief.

It very definitely is.

You print luna and 'burn' terra. Or when people get terra you print terra and burn luna. The luna tokens supposedly have value because they get a share of the transaction fees.

The printing of luna when people sell terra should be offset by luna having been burned when the terra was printed. Ideally (when the price of luna is growing) then you print less luna at sale time than you burned earlier when the terra was printed. This decreases supply of luna, making luna worth more.

So why would one want to have Luna when you got Terra? I know Terra is backed, I know Luna is speculation, not any different from doing a roulette game.

Because it's an intentionally obtuse Ponzi scheme. You can stake Terra on Anchor protocol which was advertised as up to 20% yoy return for lending your Terra. This creates demand for Terra, which in turn creates demand for Luna, as you can only mint new Terra by burning Luna. As long as there are newcomers buying into the ecosystem, Luna will increase in value.

Luna gets the returns from the assets the 'real money' was invested in. Terra doesn't.

The people using Terra give up their returns to Luna holders for the convenience of a universally acceptable exchange medium that is pegged to something else of value that isn't universally acceptable.

As with all leveraged investments to problems occur when the underlying real assets fail to perform as expected. Or at worst don't exist at all.

There is no upside to holding Terra. If the system works, it'll always be grounded to 1 dollar. Luna on the other hand can go to the moon.

The names are the cleverest part of the whole scheme.

More accurately why would you want either when the whole thing is propped up by marketing hype.

To properly answer your question, Terra has no upside: no way to 10x. So yes, gambling.

Terra does not move in value. It’s like owning cash vs owning stocks.

The cash is less risky but it’s value does not change (apart from inflation).

Stocks are more risky but may give you profit over time.

But could I trade Terra outside of this system? And say to my buddy, here is 50 Terra, and he expect it to be 50 dollars? And wouldn’t that also create an economic impetus to trade it a like a stock?

>So why would one want to have Luna when you got Terra?

There are 3 different things: Governance related, market module related, and staking related.

You can spend 50 LUNA to submit a governance proposal. The second is to stake your LUNA. When your LUNA is staked the first benefit is that you can vote on governance proposals. Proposals can be onchain changes such as modifying a parameter or an offchain change which people should respect even if there is nothing technically forcing them to follow it.

There is a limited amount of UST that exists so what happens if more people want UST? You can burn LUNA to mint new UST. In times where the demand for UST is strong enough to make UST go above $1 it may be profitable for someone to burn their LUNA to mint UST.

Every transaction has gas fees. Any swaps between stable coins have a tobin tax. Using the market module to exchange UST for LUNA has a spread fee. All of these fees are collected and then distributed to the stakers. To help protect against times when the protocol is less active the fees are actually spread out over time. Right now every 5 blocks 5/9400000 of the reward pool is paid out to people staking. 9400000 is how many blocks there are in 2 years.

> an offchain change which people should respect even if there is nothing technically forcing them to follow it

Ah, the good old trust-less blockchain. Proved by maths, not by trust and decency and conventions like traditional finance.

The vote is still proved by maths. Sometimes you want to just be able to poll the community. For example you may want to have your project translated into Spanish so you create a proposal to pay someone from the community fund $500 for translating the project's site and documentation.