As discussed in recent governance proposals, the Terra <> Luna on chain swaps serve the critical function of maintaining the stability of Terra’s stablecoins. A piece that has been less discussed is - past the initial bootstrapping using the SDR reserves, the on chain swap also serves as the only vehicle to facilitate expansions / contractions in the float of the Terra stablecoin economy.
Conservative on chain parameters can help protect the system from being bled by arbitrage or manipulation, but can also put a pretty strong cap on how much the float of Terra stablecoins can be increased/reduced by in a given time horizon. It’s of course a fine line to walk, but one that’s critical to get right to facilitate the growth of the Terra ecosystem in a responsible fashion.
In order to protect against oracle manipulation attacks it’s important that the on chain market not be more liquid than markets off chain. As the liquidity in LUNA on exchanges rises, matching (or getting just under) that liquidity on chain could be a good metric by which to adjust liquidity parameters.
The plot below shows the aggregate spot liquidity in LUNA pairs on both sides of the book. As we can see there’s a ~$200k within 1% of the of the best and ~$600k within 5%. Adjusting the on chain curve to reflect this liquidity could serve as a good first order pass to ramp up liquidity
As seen on the plot below a 10M USD = ~7M SDR pool would be a conservative base_pool parameter to reflect this liquidity. This plot is exclusive of 50bp spread fee and sets on chain liquidity to a slight margin under the liquidity off chain
To reflect the volume that is actually done in the liquid LUNA markets, the pool_decay time also needs to be adjusted to effectively ‘refresh’ the liquidity that’s available on chain. As see on the plot above, daily trade volume has been picking up over the last few weeks. Using $10M USD as a rough estimate of the ADV, setting the pool decay time to 20 minutes would enable roughly as much notional to be traded within 2% of the best
As LUNA markets continue to evolve, and as more applications on the Terra chain continue to create demand for Terra stable coins, this piece warrants continuous monitoring. A monthly visit of this topic to look at the metrics discussed above to update on chain parameters and to continue to develop better methodology could be very beneficial