Reduce UST to LUNA min_spread from 0.5% to 0.1%

Summary

The UST to LUNA market swap (Burn/Mint) has a min_spread of 0.5%.

This spread is very high and prevents efficient arbitrage that brings UST to peg with other USD stable coins.

Proposal is to change UST to LUNA min_spread to 0.1%

Motivation

UST has lost peg to other USD stablecoins on May 8th, 2022.

The UST to LUNA min_spread of 0.5% is a main factor that prevents efficient arbitrage that brings back UST peg to other USD stablecoins.

Proposal

The UST has lost peg to other USD stablecoins on May 8th, 2022.

The lost of peg has been for 34 hours and no end in-sight.

Market tried to recover peg, but failed twice , and the rate stabilized between $0.995 and $0.996.

The 0.5% min_spread is a reason that prevents effective market arbitrage, and makes it costly to restore peg.

The trading fees for most major exchanges are all betow 0.1%. Depend on the trading volume of the trader, the fees can be further reduced and can be significantly lower. E.g. Binance has 0.075% trading fee for regular user, which can be reduced to 0.015% for high volume traders.

The UST → LUNA min_spread 0.5% is very high compared to exchanges with efficient fees.

Would propose reduce UST → LUNA min_spread from 0.5% to 0.1%

To promote effective arbitrage, the UST → LUNA min_spread will need to be on par or below other major exchange trading fees (not significantly higher).

Without effective arbitrage, the community could continue to see peg loss. These peg loss will be hard to recover, due to a high min_spread of 50 bps.

Market Data

These are the market prices that are captured at the same time on Binance:

Binance: LUNA/USDT : $63.19
Binance: LUNA/UST : $63.46
Binance: UST/USDT: $0.9954

$63.19 / 63.46 ~= 0.9957

During the last 10 hours, the UST is consistently 40-50 bps below USDT.

Other market shows the same gap (FTX: LUNA/USD, KuCoin: LUNA/UST, KuCoin: USDT/UST)

Burn/Mint as Arbitrage

The Terra Burn/Mint function is intended to use market price of LUNA/USD to determine the market price for Mint and Burn rate of Luna and UST.

It is intended as the arbitrage method to bring UST to be pegged with USD algorithmically.

If the trading spread of Burn/Mint is 0.5% (50 bps), an arbitrage trader would be hard to bring the peg to be less than 50 bps, yet at the same time obtain a profit for doing so.

With a large spread (50 bps), the pegging of UST and USD within 50 bps would not be based on arbitrage algorithm, but based on people’s belief and confidence.

Human belief and confidence are subjective. Without arbitrage, there could be a sustained long period of time of loss of peg of UST.

Suggested Spread

A typical peg is consider 0.1% or less variation of the target asset price.

This is to propose to change UST to LUNA min_spread to 0.1%, for effective pegging between UST and USD

Notes

Please kindly suggest if alternate parameters are to be considered.

Thank you

5 Likes

There are a lot of speculators in the market that are betting UST peg would fail.

While understanding the Luna Foundation Guard (LFG) is making an effort to engage with trading firms to bring back the peg, and is working towards buying more BTC. Nevertheless, the market have its own way of working.

If LFG go with more leverage, the speculators would only try to push the boundaries and push the liquidation of the known counter party.

The UST and LUNA has its own pegging mechanism, using Mint and Burn. However, the majority of the current market move (depeg of UST and price drop of LUNA) are not from this Mint and Burn, but from speculative trading activities.

E.g over the last 3 days, up to this moment, total ~$400m UST were burned.

In the meantime, the Anchor Protocol withdrawal is ~$7B.

The drastic difference leaves a large amount of UST in circulation, and will continue to push the UST towards de-peg, which in turn pushes Luna price.

Even LFG has $3.5B bitcoin in capital (current value probably much less), running against the market will be dangerous for Terra.

In extreme situation like this, Terra cannot save both UST peg, and save LUNA price at the same time.

LGF’s limited capital is risky, compared to speculative traders from everywhere.

Remember 2008? when each and every Investment Bank were attacked, one by one, until they were bankrupt, or got acquired, or got huge external funding.

Speculators does not stop, until they know there are no weakness to exploit.

Allow more efficient UST burning and LUNA minting, will in the short term put pressure to LUNA price, but will be an effective way to bring UST back to peg, which will eventually stabilize LUNA price.

Yes, billion of UST will be burned, and LUNA will be diluted significantly. Nevertheless, there are no limit in LUNA supply, this market mechanism will actually work to bring stable UST and stable LUNA price (although likely at lower price point for LUNA).

If efficient Burn/Mint is not available for an extended period, this can leave UST to be out of peg for a long period, which will significantly undermine the confidence in the market, and continue to encourage speculators to push down the peg and can potentially crash entire Terra Ecosystem.

Please kindly consider, or suggest other perspectives.

Thank you.

5 Likes

8 Billion withdrawn from Anchor Protocol. (Peak was $14B, $14B - $6B = $8B)

1 Billion burned through pegging mechanism (Burn UST, Mint LUNA)

A lot of UST are still in trader’s hands.

With current burning speed, the UST de-peg situation will take several days to resolve.

4 Likes

I support the direction of this proposal.
However I do not know the intricacies and ramifications of changing the min_spread.
From reading Market — Terra Docs documentation and On swap fees: the greedy and the wise | by Nicholas Platias | Terra Money | Medium it seems that the reason for the spread is to mitigate against front running.

However as we can see, the current parameter of 0.5% is not productive to the current situation.
Perhaps a dynamic min_spread parameter would be more effective?
Again, I would like to state a disclaimer that I am not that technical and do not understand the complete wider consequences of this - however I am suggesting it for further discussion.

Perhaps something like:
if UST < 1.00 USD then MinSpread = 0.1%
if UST < 0.90 USD then MinSpread = 0.01%

2 Likes

I think a dynamically adjusted min_spread parameter would be be more effective going forward.

In the meantime, I think the min_spread parameter needs to be manually adjusted as quickly as possible.

2 Likes

Or possibly increase the size of the base pool.

2 Likes

Agree. This is the main reason that UST has lost peg for several days now and is slow to recover.

2 Likes

Create another topic to for base pool increase:

3 Likes