Olaf Carlson-Wee Explains the UST Fiasco

Transcript

luna and ust so you're kind of just talking about these systems that have virtuous cycles on the way up and then maybe the opposite occur on the way down can you just walk folks who might not be familiar with what exactly is the relation like what is ust what's the relationship with luna and what happened right now like why have we seen a d-pegging yep so um okay so it's it's sort of a complex system um but it's useful to just understand sort of the theory behind um different stable coin mechanisms you know the there's kind of three i would say broad-based categories um of stable coins one is where there's collateral but the collateral is not on the blockchain

um so this is like um usdc this is tether um this is where the collateral is held in by some central entity off the system um and then you can you know redeem you know the the stable coin that's on the blockchain for cash that's sort of just in a bank account off the blockchain um so those systems are you know relatively simple conceptually the problem is of course that there's kind of a central entity that that controls all that collateral the second type is where the collateral is actually held on the blockchain this is what the maker dow system does so it's fully collateralized stablecoin but all the collateral can be visualized and

seen on the blockchain and it's not controlled by a central entity so it's decentralized in the sense that there's not one single entity that you know in theory could freeze the collateral or or seize the collateral or something like that but it's a trickier system to reason about it's just a little bit more um complex um and you know it's it's harder to build it's harder to scale but it's it's it's a lot more resilient um than the first type then there's kind of a third type that people generally refer to as senior edge or or algorithmic stable coins and um this is where you know the peg is is backed up

um so there's this the stable coin itself and then there's a secondary asset that um sort of represents like an interest in um the stable coin system sort of and it kind of acts as collateral of last resort um for that stable coin um it's important for the market cap of that collateral to stay above um the market cap of the stable coin and the idea here is you can always redeem the stable coin for one dollar worth of the underlying um and you can redeem the underlying for

one dollar of the stablecoin and so in that way if the stablecoin ever goes above a dollar or below a dollar you have arbitragers that um you know do this collateral exchange and can make a profit and the further it goes off peg the larger those arbitragers stand to earn so if it if it goes off the peg by one percent you know an arbitrager can earn one percent if it goes off um by 99 an arbitrager in theory if it gets back to the peg stands to make a 100x return right so you you kind of increase um um reward as the peg becomes um undone and you're increasing risk in a sense

for the arbitragers um what's tricky about this system um and in the case of of tara luna is that the the collateral is is highly correlated with the the you know success of the stable coin so in the case of a system like make or dell dye has lots of different collateral assets um they're all crypto so they're all broadly correlated on some level but they're not you know it doesn't have um mkr like the maker token as the collateral in the system um you know so one way to view tara luna

is it it's sort of like the luna token really only exists in in a way to act as collateral or or seniority shares whatever you want to call it um for that ust stable coin so you know what we found out here is that the problem is that when that those two assets are correlated like as the pay gets undone people lose faith in the system and so the price of luna drops and as the price of luna drops it becomes harder and harder to use that collateral to restore the pig and it's like a confidence loop um so you know it's it because the two assets are correlated um

and you really depend on you know luna retaining value in order for ust to to um be sort of backed or or collateralized um you just see this feedback loop whereas people lose confidence um you know in one they lose confidence in the other and so you know if these two things were sort of uncorrelated you know it might have a better chance of working um in this case you know there's like not enough luna in a sense to redeem um for ust um and then you know in that case like the ust isn't really backed now on top of all this mechanism i'm talking about

which is sort of the algorithmic stable coin mechanism there's also a foundation um collecting you know tens of thousands of bitcoin to back the system so it's sort of like partially algorithmic and like partially offline collateralized sort of in a usdc or tether style capacity um but the the problem is that that offline collateral you know wasn't i mean i don't think it is significant enough here to backstop the entire system so you have this kind of partial collateralization and then you have this algorithmic um backing but you know neither of them is sort of

big enough here so i mean it's and just to timestamp this i mean it's it's may 11th in the morning so you know i this is very much like happening right now um i i don't want to talk like it's it's 100 done but um you know it does feel like these these unwind um has these kind of irreversible confidence game um effects at play