Why 1 UST = 0.7189 dollar
My newbie crypto friend the other day told me to have a look at the amazing Anchor Protocol, which warrants a ~19.5% “risk free passive income” from his chunky UST deposits that he bought using his real fiat cash. Ouch!
Guys, let’s be realistic, there is no such thing as “free lunch”.
Chapter 1: Why 1 UST = 0.7223 dollar
By design, UST is backed Luna another crypto currency, so essentially it is a crypto currency “derivative”.
This sounds familar? CDOs that caused the sub-prime financial crisis in 2008 are also “derivatives” that derived nominal values from the underlying assets thus having certain flaws by design.
During the Normal Market Conditions (when there are abundunt liquidty from retail/institutional investors), 1 UST could be swapped (i.e. traded) back 1 USDC or 1 USDT or directly with fiat currencies through many CEXs.
USDC and USDT are only two real dollars or dollar assets backed stablecoins in the crypto world.
1 USDC is fully backed by 1 fiat dollar and could be redeemed (or “burnt”) back to 1 fiat dollar.
Similarily, 1 USDT could be redeemed through a process (though takes time) via its issuer back to 0.99 fiat dollar roughly after fees. So almost as good as 1 USDC.
The above holds during the Normal Market Conditions as well as during the Stressed Market Conditions (think of a market panic, accompanied by stress, volatile price movements, chaos, fake news, and network jams, or simply lack of liquidity during the “crypto winter”).
However, UST can’t do any of this. Because UST is not “pegged” to 1 fiat dollar or not backed by 1 fiat dollar.
During the Stressed Market Conditions, UST might loss its anticipated 1:1 peg to 1 USDC, 1 USDT, or 1 fiat dollar easily.
First of all, the UST “peg” itself is not real since there is no fiat dollars circulating in the crypto world. So the “peg” of 1:1 to 1 fiat dollar itself is flawed.
It is really a “common agreement” or “gentlemen’s agreement” or just “confidence” in the UST/Luna/Terra system — which is now as the protocal is really hyped.
No fiat dollar is backing UST and nowhere you can “redeem” your UST back to 1 fiat dollar. Even Luna Foundation Guard can’t help you.
This is a common issue with many algo stablecoins or crypto-native stablecoins (for instance DAI). These non-backed algo-balanced crypto native stablecoins can’t get redeemed back to real world fiat currencies.
The only option is to trade, i.e. sell to the next willing buyer.
You can only sell or trade your UST to another cryptocurrencies like USDC/USDT/BTC/ETH/SOL through CEXs or DEXs or dApps.
So it’s not “redeem”, it is really a trade, or a secondary sell of UST. And the trading price is always subject to market conditions.
Under the Stressed Market Conditions, when no one has confidence anymore in Terra, Luna, UST, Anchor protocol, you will have to sell your UST deposits at discounts mostly likely.
Remember, traders, arbitrager, flash boys are not angels, they are mecenaries. They won’t be holding the bags. They only trade and arbitrage when there is a way out on the back-end to make a nice profit.
The so called market arbitrage mechanism that keep UST’s imaginary “peg” to 1 fiat dollar will only work during Normal Market Conditions.
In stressed times, everyone will run for themselves.
So the reality is, you keep your UST, and Luna Foundation Guard or CEXs keeps your hard earned fiat dollars (or any other assets they used your dollars to purchase).
In other words, your UST is worth at best 1 USDC/USDT/1 fiat dollar, and might be less than 1 USDC/USDT/1 fiat dollar during stress times.
The GBTC comparison
The same issue is faced by the very popular GBTC, whose trust shares once issued can only be sold in a secondary market to the next willing buyer & can not really redeemed back as Bitcoins. So GBTC is trading consistently at a discount over the past period like~10–30% discount to Bitcoins. Of course, this is also partly due to its ~2% management fees.
If we use the GBTC discount (-28.11% per 31 Mar 2022) as the industry benchmark as a rough proxy/indicator, your 1 UST is actually only worth 0.7189 fiat dollar.
See below the screen cap where you can calculate the discount = 30.54 (market price)/42.28 (intrinsic value) -1 = -28.11%.
Think about it guys, after earning 1 year of ~19.5%, your UST will be worth 0.8592 fiat dollar. Congrats still not yet breakeven after 1 year.
So if you buy a UST now, you suffer an immediate loss of -28%, which is greater than your return of +19.5% over one year’s time. Not a good trade in my view.
Remember, SAFETY is always the first question you ask for any assets incl. crypto. Yield only comes second after SAFETY.
When I have time, I will write more about UST/Luna/Terra Protocol and Anchor Protocol in Chapter 2.