A (partially) collateralized cross-chain stablecoin based on UST

Been also pitching this on Terra as a potential mechanism to both help make UST holders whole, while bootstrapping collateral. There’s no reason this couldn’t be built on Secret too (maybe even Shade can implement it?). Still preliminary, and opening it to discussion.

While the details of the ‘right’ stablecoin model are to be fleshed out, many now believe that a partially or fully collateralized stablecoin is the way to go. A big question is how do you get enough collateral to get started at scale.

I think that’s where the incentives of bailing out UST holders and bootstrapping collateral converge. I’m gonna assume there’s a partially collateralized/partially algorithmic stablecoin involved in this (S), with an accompanying volatile asset (V) (like Luna, Shade, Frax and other algorithmic coins have).

  1. Pre-launch: There needs to be some discount factor put on UST. For the sake of simplicity let’s assume a UST in this new model is valued at $0.4. Note that this amount should be determined by the protocol’s requirements - i.e., how much partial collateral the protocol needs to safely work (this will be clear in the next section).

  2. Launch: Each UST gets an option to buy S at a discount proportional to #1. In our example, this means that any UST holder can burn their UST and buy 1S = $0.6 (should be done in a relatively stable basket of assets to serve as proper collateral). With this, the protocol can amass a large amount of collateral thanks to the large supply of UST, which accompanied by a proper partially-collateralized protocol should provide the necessary stability. The options should have an expiry, e.g., 6 months.

  3. Since a lot of people may not want (or be able to) supply the funds necessary, the option itself should have a liquid open market. This would allow people to essentially ‘sell the right’ for a certain discount (e.g., if the value of the underlying is set as $0.4, then maybe the option goes for $0.35 or whatever the market decides).

  4. Improving/avoiding initial bank-runs: Depending on the protocol, this may not even be necessary, but if once we settle on a partially-collateralized stablecoin protocol we feel that it may not be robust depending on the starting condition (i.e., early liquidity dumping their S tokens because their discounted UST suddenly has some value again), then we can improve the model in several ways to make it more robust:

a. Only give 1:1 tokens based on the collateral supplied. For example, if a UST holder pays $0.6 in collateral, then they get 0.6S tokens immediately. The rest are given with a lockup + vesting, which allow the protocol to get to its steady-state first.

b. Like (a), but instead of giving the rest in S tokens, give it in V tokens with some discount to offset for the fact that this is a volatile asset.

I’d love to get feedback on this and get the discussion rolling. IMO, this is a way to both make UST holders whole, while continuing from where Terra left off. I would also love to see Terra (or anyone from their ecosystem) build this!


Agree You could also want to reply linking this proposal into this one this Terra V2 Upgrade - Governance & Proposals - Terra Research Forum as they are pretty confluent.

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What if a new platform was started where people could deposit almost any coin available on the cosmos? You could start with a few of the main ones and as people started to use the platform they could vote to add additional coins. In exchange for depositing your coins you would received a portion of the value in stable coins. It would be each user’s responsibility to maintain their collateralization ratio and if they go below a certain amount they could be liquidated down to a certain threshold. This would have a decentralized method of maintaining enough collateral and the responsibility would be shared by all depositors. If depositors did not maintain their level or better, than liquidators would profit from fixing people’s ratios. Motivation for using the platform would be that the stable coins are “lent” at 0%, after all it is their own money they are borrowing against. Creditors could all receive a reward amount, like staking, in the platform’s currency which could be used for governance and other use cases. The way this could be used to save the UST holders is that there could be a certain amount of UST per day that could be burned which would lower the collateralization ratio of the platform from something high initially like 900% down to say 400% which would happen over months or years as the platform took on more deposits to be able to sustain the rise in burning and lowering of collateralization ratio.

What’s keeping UST from going to 0 and depleting the collateral reserve?


In this model you need to somehow restore some sort of value on UST (currently valued at 10c in the market, so pretty much 0). In order to do this, you need people to buy in and give a vote of confidence to this plan outside of Secret, so that you generate demand for UST.

Let’s assume you get that part in and you secure somehow Jump’s support, or Jane Street, or whoever was trying to rescue the peg + TFL makes some sort of statement support this. Great now UST has some sort of demand in the market for this swap.

The problem is that as people liquidate UST for this swap, you need to instantly sell this UST and back it with some sort of stable collateral (UST is only worth anything in this scenario for as long as the swap lives), generating a sell pressure of equal magnitude than the demand (also don’t forget about the sell pressure of people still waiting to exit who don’t care about this).

In short, the proposal seems to generate a bailout where apes and speculators in the market buy UST to provide newly demand for UST, while soaking up the sell volume as you sell that UST back to buy whatever collateral of choice.

At that point, you might as well wonder why not start a new raise or do a public sale? Maybe I missed something

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Is the intent to eventually substitute the UST collateral for a more stable asset class? (Ideally something wholly uncorrelated with crypto)

Agree it’s better keep the collateral decentralized

Interesting proposal. It is indeed very preliminary. For this to work (and avoid another disaster) the model should be very clear and robust from the start, otherwise it could be another disaster that we don’t need. We also need to have solid collateral.

We don’t need that many stablecoins. We need the right model. I hope Shade is building exactly that, but the model is not quite ready and robust yet.

IMO fiat currencies demonstrate the lack of any true need for collateralization. The US banking system has the same vulnerability to bank runs as any algo stable coin. In fact digital USD is probably more vulnerable to bank runs than most algo stables. The difference is that US banks merely have a mechanism to stop them from occurring in the first place (public trust created by FDIC). Purely rational, non-ideologically committed, LUNA holders on the other hand were always incentivized to sell during a bank run because increasing supply and falling LUNA prices were the only possible game theoretical result of burning UST.

The problem with that model was simply the existence of an extended time delay in the repeg. If enough UST would have been burned to repeg immediately, there never would have been a run on LUNA, even if its value dropped dramatically with the supply increase. Far less UST would have needed to be burned. Luna survived chaotic and volatile price swings without spiraling before. The death spiral only exists if you know LUNA’s price has to fall in the future. And that is only guaranteed if you know a lot more UST must be burned in the future. And that is only possible if arbitragers can’t burn nearly enough UST fast enough for most people to notice and begin to panic.

In the truest sense, UST was never backed by LUNA. It was backed by faith in the mechanics of arbitrage that prevented bank runs by guaranteeing a repeg… eventually. The idea of using a stabilizer coin that was inherently valuable for securing the network sounded like a great idea until inflation diluted governance and created vulnerabilities in the blockchain consensus itself. It would have been better to use a coin that collected protocol fees, but did not create security dependencies. LUNA always repegged before because a larger percentage of it’s holders were true believers, and because the incentive to sell was smaller and didn’t last long enough for everyone to consider. Perhaps the biggest mistake LUNA made was trying to grow too quickly and take over the market while their mechanics were still largely untrusted. Sadly, it may be best that it failed now. The $10 billion BTC pool liquidity probably would have been sufficient to prohibit bank runs for a very long time, but Terra’s mechanics still had vulnerabilities that might have caught up with it in- with even greater carnage in the future.

Over collateralizing stable coins with backing assets is both capital inefficient and less secure than market mechanics and game theory. A coin backed 200% by BTC would still have a bank run when the price of BTC fell below the backing. That isn’t inevitable with an algo stable coin. It would be better to rely on arbitrage, tiered staking incentives that lock coins and reduce the potential for temporary bank runs, and possibly disincentive/penalty/repeg mechanisms directly embedded in the act of transferring tokens below peg.

I think it is entirely possible to create an algo stable that is safer than an asset backing. Further experiments should limit, study and constantly measure their vulnerability to various attacks (did anyone do the math on degenbox liquations?). Pre-negotiated bailout plans should exist at every stage. Something as simple as purchasing outside insurance would have prevented LUNA’s death spiral without fixing any of its vulnerabilities.

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Why not dedicate a portion of the collateral to funding a short position using perps…?

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