Staking rewards. It's marketed as a necessary feature of PoS cryptocurrencies, but it isn't really necessary if the cryptocurrency is actually centralized anyways. Centralized cryptocurrencies like USDT just use it to entice buyers with rewards for just holding it, creating inflation at the cost of everyone else.

This is a major reason against Proof-of-Stake: if you don't reward stakers, then they will be incentivized to abuse their powers and double spend. If you do reward stakers, it creates a ponzi-like incentive structure like this.

UST was appealing because you could supply it in Anchor protocol, which was a money market. Anchor advertised nearly 20% APY on your supply, so it was appealing to convert your fiat to UST and then supply it to Anchor like a high interest savings account.

USDT also doesn't incentivize holders of the token. Centralized or decentralized platforms may offer incentives for depositing token though, but this isn't done by Tether itself.

Anchor lends it out to someone else at >20% APR because that other person is… brain dead? Who would accept that?

But again, where do the new Terra coins come from? If Anchor pays me in more stable coins, they had to buy USD to be allowed to mint them right?

Does that mean I bought Terra with USD to allow Anchor (which is Terra?) to sell my Terra to get USD to lend out at usurious rates to make USD to buy Terra to make up what they sold if mine and pay my returns?

Is that right?

How does anyone take any of this at face value? Why not just take USD to lend USD to get USD to return USD?

I’m ignoring answers like money laundering and avoiding KYC and other financial regs. If we assume everything is truly on the up-and-up how does this ever make any sense?

And again who borrows money, probably denominated in some crypto, at >20%? Isn’t that kind of the crux of the whole system? You’d need those people for this to work?

I understand, though disagree with, many pro-BTC arguments. I even understand the pro-NFT arguments. This… I can’t think of any plausible argument from my current understanding.

They're probably crypto speculators looking to lever up. If crypto could double in one year then borrowing at 25% isn't crazy.

where do the new Terra coins come from? If Anchor pays me in more stable coins, they had to buy USD to be allowed to mint them right?

Terra was pegged to $1 but it wasn't backed by USD. Terra was backed by Luna and it was possible to convert Luna to Terra without any USD being involved. People called this out as unsafe in 2021.

Why not just take USD to lend USD to get USD to return USD?

I'm not sure regulators would allow anyone to do this kind of lending in the real banking system.

I’m ignoring answers like money laundering and avoiding KYC and other financial regs.

Don't ignore it. The purpose of a lot of DeFi is to allow people to do things that regulations don't allow.

And again who borrows money, probably denominated in some crypto, at >20%? ... You’d need those people for this to work?

AFAIK Anchor never had enough borrowers to sustain itself. I suspect the long-term plan was to draw in deposits with the 20% rate as a teaser, then lower rates over time and hope depositors stayed due to inertia. Other lenders like BlockFi and Crypto.com offer have also lowered their rates multiple times over the past 18 months.

I'm not trying to defend Terra/Luna/Anchor here; it was always doomed and it failed. But it wasn't obviously doomed; only a few people did the math that showed the danger. If you only look at the surface it looks like it works.

The reality is that these juiced returns were not sustainable and in the end made it even harder for them to defend the peg of their poorly designed pegging mechanism.

You can't compare the returns in the crypto space to the banking sector. At the moment leverage on an exchange (Binance) costs 7.3% PA at the moment. The exchange also takes a fixed percentage of your trade as a fee. This is why locking up stable coins on Binance nets you more interest than the average savings account. A bank can't or won't lend you money against crypto.

Another scenario is someone who holds say Bitcoin. They have a decent income and want to buy a new car. If they think Bitcoin will appreciate in value instead of selling Bitcoin to buy a new car (which will trigger a capital gains taxable event) they can just borrow against their Bitcoin. The cash or stablecoin for the loan has to come from somewhere. Like I said above banks won't accept Bitcoin for a secured loan.

Collect many of those short-term high-interest loans into a single bucket, and you have a longer-term high interest facility. Like being an LP in a credit fund. So there is a fairly high fundamental yield. Not 20%, but maybe 6%.

Second, as the GP mentions, they were also using their marketing budget to pay an unsustainably high yield to excite and entice investors. So on to the 6%, add another 4% of VC money.

Finally, they were underestimating the risk of the underlying loans defaulting, thereby causing them to overestimate the APY on the pool. That brought them to a place where they thought they could pay 20% instead of 10%.

There might be more to it than that but that's what I understand.

People deposited to receive incentives. They borrowed to receive incentives. That’s it.

The APY was chosen arbitrarily. Nobody there underestimated default risk.

Dumb place to stick your money FWIW.

You can trade your stablecoins against other cryptocurrencies that they are paired against on exchanges or you can loan your stablecoins to a platform for a profit so they can lend it out to others for a profit. Banks do the same thing. When you deposit money into a bank account you are essentially lending the bank money. We call it a deposit but it's not like the bank is actually holding 100% of everyone's deposits.

> If they promise returns where are they supposed to come from? If my coins are pegged to USD how do they appreciate? Or is the idea they just give me more for holding?

A low risk way of generating a return would be the platform lends out the coins you have locked as a secured loan for a profit.

The high risk way of generating a return would be the platform you have your stable coins locked up on finds another lending platform generating a higher return than they are promising and they invest your locked up funds there.

> But if the coins are pegged where do they get the money for the new coins they’re giving me?

They are created out of thin air. Basically they have to incentivise people to use their coins while keeping enough funds on hand to mop up any excess liquidity on exchanges when the price of their stable coin breaks peg. Governments do the same thing with national currencies. They incentivise you to use national currency by naming it legal tender and enacting capital controls as we have seen recently in Russia, Turkey and Lebanon.

If they don’t promise returns why would anyone invest in a stablecoin?

In some countries trading from crypto to crypto is not a taxable event unlike trading crypto to dollars. Stablecoins were embraced by exchanges too so it really is a lot easier to trade crypto for crypto than it is to trade currency for crypto or vice versa. Essentially people don't invest in stable coins for the most part. They use them because they have a greater utility than actual dollars.

That said buyer beware! Cryptocurrency is a largely unregulated space and regulations exist for a reason!

Terra had a sister coin called Luna which it planned to use to keep Terra stable. Luna had the price dynamics of ETH or BTC, where it's value depended solely on the whims of the market. The whole thing was a perpetual motion machine that failed very predictably. Matt Levine has some good coverage.

At the very least, similarly structured algorithmic stablecoin schemes should be identified as a species of scam and made illegal. Knowingly trying to pull this kind of thing on people who are going to be left holding the bag and wondering when their Luna2 airdrop is going to show up in some piece of tech that they don't understand... it takes malice.

Of course, the flaw in this whole arrangement, is that if LUNA is in a death spiral and money is only really flowing out of UST/LUNA, then the peg is not maintained.

Tax evasion and money laundering

E.g., there's likely high demand for USDT to move money out of Russia, given the currency control and Visa/MC restrictions. But if you're currently in Russia sitting on a massive pile of USDT, you probably don't want a massive ruble exposure either, and hodl'ing that USDT seems like a fairly solid strategy for the time-being?